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Generalized Recovery

Lasse Pedersen, David Lando () and Christian Skov Jensen
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Christian Skov Jensen: Copenhagen Business School

No 935, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We characterize when physical probabilities, marginal utilities, and the dis- count rate can be recovered from observed state prices for several future time periods. Our characterization makes no assumptions of the probability distribu- tion, thus generalizing the time-homogeneous stationary model of Ross (2015). Our characterization is simple and intuitive, linking recovery to the relation between the number of time periods and the number of states. When recovery is feasible, our model is easy to implement, allowing a closed-form linearized solution. We implement our model empirically, testing the predictive power of the recovered expected return and other recovered statistics.

Date: 2016
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