Estimating forward looking distribution with the ross recovery theorem

Takuya Kiriu, Norio Hibiki

Research output: Contribution to journalArticlepeer-review

2 Citations (Scopus)

Abstract

Ross (2015) introduced a remarkable theorem, named the “Recovery Theorem.” It enables us to estimate the real world distribution from the risk neutral distribution derived from option prices under a particular assumption about a representative investor's risk preferences. The real world distribution estimated with the Recovery Theorem is suitable for many financial problems such as market risk management and portfolio optimization due to its forward looking nature. However, it is not easy to derive the appropriate estimators because of an ill-posed problem in the estimation process. We propose a new method to derive the accurate solution by formulating the regularization term involving prior information. Previous studies propose methods to estimate the real world distribution, but they do not investigate the estimation accuracy. We show the effectiveness of the proposed method through the numerical analysis with hypothetical data.

Original languageEnglish
Pages (from-to)83-107
Number of pages25
JournalJournal of the Operations Research Society of Japan
Volume62
Issue number2
DOIs
Publication statusPublished - 2019 Jan 1

Keywords

  • Estimation
  • Finance
  • Recovery Theorem
  • Regularization

ASJC Scopus subject areas

  • Decision Sciences(all)
  • Management Science and Operations Research

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