TY - JOUR
AU - Borovička, Jaroslav
AU - Hansen, Lars P
AU - Scheinkman, José A
TI - Misspecified Recovery
JF - National Bureau of Economic Research Working Paper Series
VL - No. 20209
PY - 2014
Y2 - June 2014
DO - 10.3386/w20209
UR - http://www.nber.org/papers/w20209
L1 - http://www.nber.org/papers/w20209.pdf
N1 - Author contact info:
Jaroslav Borovička
Department of Economics
New York University
19 W. 4th Street, 6th Floor
New York, NY 10012
E-Mail: jb4457@nyu.edu
Lars P. Hansen
Department of Economics
The University of Chicago
1126 East 59th Street
Chicago, IL 60637
Tel: 773/702-8170
Fax: 773/702-8490
E-Mail: lhansen@uchicago.edu
José A. Scheinkman
Department of Economics
Columbia University
New York, NY 10027
E-Mail: js3317@columbia.edu
AB - 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.
ER -