TY - JOUR
AU - Ross,Stephen A.
TI - The Recovery Theorem
JF - National Bureau of Economic Research Working Paper Series
VL - No. 17323
PY - 2011
Y2 - August 2011
DO - 10.3386/w17323
UR - http://www.nber.org/papers/w17323
L1 - http://www.nber.org/papers/w17323.pdf
N1 - Author contact info:
Stephen A. Ross
MIT Sloan School of Management
100 Main Street, E62-616
Cambridge, MA 02142
Tel: 617/258-8371
Fax: 203/772-1365
E-Mail: sross@mit.edu
AB - We can only estimate the distribution of stock returns but we observe the distribution of risk neutral state prices. Risk neutral state prices are the product of risk aversion – the pricing kernel – and the natural probability distribution. The Recovery Theorem enables us to separate these and to determine the market’s forecast of returns and the market’s risk aversion from state prices alone. Among other things, this allows us to determine the pricing kernel, the market risk premium, the probability of a catastrophe, and to construct model free tests of the efficient market hypothesis.
ER -