An Empirical Analysis of the Ross Recovery Theorem
Type
working paper
Date Issued
2014
Author(s)
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.
Language
English
Keywords
Risk-neutral density
real-world density
pricing kernel
risk aversion
predictive information
Ross recovery
HSG Classification
contribution to scientific community
HSG Profile Area
SEPS - Quantitative Economic Methods
Refereed
No
Publisher
SEPS Economic Working Paper Series
Number
1411
Subject(s)
Eprints ID
234838