NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Misspecified Recovery

Jaroslav Borovička, Lars P. Hansen, José A. Scheinkman

NBER Working Paper No. 20209
Issued in June 2014
NBER Program(s):AP

Asset prices contain information about the probability distribution of future states and the stochastic discounting of these states. Without additional assumptions, probabilities and stochastic discounting cannot be separately identified. Ross (2013) introduced a set of assumptions that restrict the dynamics of the stochastic discount factor in a way that allows for the recovery of the underlying probabilities. We use decomposition results for stochastic discount factors from Hansen and Scheinkman (2009) to explain when this procedure leads to misspecified recovery. We also argue that the empirical evidence on asset prices indicates that the recovered measure would differ substantially from the actual probability distribution and that interpreting this measure as the true probability distribution may severely bias our inference about risk premia, investors' aversion to risk, and the welfare cost of economic fluctuations.

download in pdf format
   (307 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w20209

Users who downloaded this paper also downloaded* these:
Hansen w20394 Uncertainty Outside and Inside Economic Models
Andersen, Fusari, and Todorov w18046 Parametric Inference and Dynamic State Recovery from Option Panels
Borovička, Hansen, and Scheinkman w20104 Shock Elasticities and Impulse Responses
Grossman and Krueger w4634 Economic Growth and the Environment
Lustig, Stathopoulos, and Verdelhan w19623 The Term Structure of Currency Carry Trade Risk Premia
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us