Generalized Recovery

Christian Skov Jensen, David Lando, Lasse Heje Pedersen

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Abstract

We characterize when physical probabilities, marginal utilities, and the discount rate can be recovered from observed state prices for several future time periods. We make no assumptions of the probability distribution, thus generalizing the time-homogeneous stationary model of Ross (2015). Recovery is feasible when the number of maturities with observable prices is higher than the number of states of the economy (or the number of parameters characterizing the pricing kernel). When recovery is feasible, our model allows a closed-form linearized solution. We implement our model empirically, testing the predictive power of the recovered expected return and other recovered statistics.
Original languageEnglish
JournalJournal of Financial Economics
Volume133
Issue number1
Pages (from-to)154-174
Number of pages21
ISSN0304-405X
DOIs
Publication statusPublished - Jul 2019

Keywords

  • Recovery
  • Asset pricing
  • Pricing kernel
  • Predicting returns

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