An Empirical Analysis of the Ross Recovery Theorem

Francesco Audrino, Robert Huitema () and Markus Ludwig ()

No 1411, Economics Working Paper Series from University of St. Gallen, School of Economics and Political Science

Abstract: Building on the results of Ludwig (2012), we propose a method to construct robust time-homogeneous Markov chains that capture the risk-neutral transition of state prices from current snapshots of option prices on the S&P 500 index. Using the recovery theorem of Ross (2013), we then derive the market’s forecast of the real-world return density and investigate the predictive information content of its moments. We find that changes in the recovered moments can be used to time the index, yielding strategies that not only outperform the market, but are also significantly less volatile.

Keywords: Risk-neutral density; real-world density; pricing kernel; risk aversion; predictive information. (search for similar items in EconPapers)
JEL-codes: C14 C58 G13 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2014-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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