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Arbitrage-based recovery

Author

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  • Horvath, Ferenc

Abstract

We develop a novel recovery theorem based on no-arbitrage principles. To implement our Arbitrage-Based Recovery Theorem empirically, one needs to observe the Arrow–Debreu prices only for one single maturity. We perform several different density tests and mean prediction tests using more than 26 years of S&P 500 options data, and we find evidence that our method can correctly recover the probability distribution of the S&P 500 index return on a monthly horizon, despite the presence of a non-trivial permanent SDF component.

Suggested Citation

  • Horvath, Ferenc, 2025. "Arbitrage-based recovery," Journal of Financial Economics, Elsevier, vol. 163(C).
    • Handle: RePEc:eee:jfinec:v:163:y:2025:i:c:s0304405x24001922
    DOI: 10.1016/j.jfineco.2024.103969
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    More about this item

    Keywords

    Recovery theorem; Physical probabilities; Stochastic discount factor; No-arbitrage;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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