Misspecified Recovery

Jaroslav Borovicka, Lars Peter Hansen, JosÉ A. Scheinkman

    Research output: Contribution to journalArticle

    Abstract

    Asset prices contain information about the probability distribution of future states and the stochastic discounting of those states as used by investors. To better understand the challenge in distinguishing investors' beliefs from risk-adjusted discounting, we use Perron–Frobenius Theory to isolate a positive martingale component of the stochastic discount factor process. This component recovers a probability measure that absorbs long-term risk adjustments. When the martingale is not degenerate, surmising that this recovered probability captures investors' beliefs distorts inference about risk-return tradeoffs. Stochastic discount factors in many structural models of asset prices have empirically relevant martingale components.

    Original languageEnglish (US)
    Pages (from-to)2493-2544
    Number of pages52
    JournalJournal of Finance
    Volume71
    Issue number6
    DOIs
    StatePublished - Dec 1 2016

    Fingerprint

    Investors
    Martingale
    Asset prices
    Stochastic discount factor
    Discounting
    Probability distribution
    Risk adjustment
    Structural model
    Inference
    Risk-return tradeoff

    ASJC Scopus subject areas

    • Accounting
    • Finance
    • Economics and Econometrics

    Cite this

    Borovicka, J., Hansen, L. P., & Scheinkman, J. A. (2016). Misspecified Recovery. Journal of Finance, 71(6), 2493-2544. https://doi.org/10.1111/jofi.12404

    Misspecified Recovery. / Borovicka, Jaroslav; Hansen, Lars Peter; Scheinkman, JosÉ A.

    In: Journal of Finance, Vol. 71, No. 6, 01.12.2016, p. 2493-2544.

    Research output: Contribution to journalArticle

    Borovicka, J, Hansen, LP & Scheinkman, JA 2016, 'Misspecified Recovery', Journal of Finance, vol. 71, no. 6, pp. 2493-2544. https://doi.org/10.1111/jofi.12404
    Borovicka J, Hansen LP, Scheinkman JA. Misspecified Recovery. Journal of Finance. 2016 Dec 1;71(6):2493-2544. https://doi.org/10.1111/jofi.12404
    Borovicka, Jaroslav ; Hansen, Lars Peter ; Scheinkman, JosÉ A. / Misspecified Recovery. In: Journal of Finance. 2016 ; Vol. 71, No. 6. pp. 2493-2544.
    @article{6d6844bc67f24359bc879d7d2e029ac2,
    title = "Misspecified Recovery",
    abstract = "Asset prices contain information about the probability distribution of future states and the stochastic discounting of those states as used by investors. To better understand the challenge in distinguishing investors' beliefs from risk-adjusted discounting, we use Perron–Frobenius Theory to isolate a positive martingale component of the stochastic discount factor process. This component recovers a probability measure that absorbs long-term risk adjustments. When the martingale is not degenerate, surmising that this recovered probability captures investors' beliefs distorts inference about risk-return tradeoffs. Stochastic discount factors in many structural models of asset prices have empirically relevant martingale components.",
    author = "Jaroslav Borovicka and Hansen, {Lars Peter} and Scheinkman, {Jos{\'E} A.}",
    year = "2016",
    month = "12",
    day = "1",
    doi = "10.1111/jofi.12404",
    language = "English (US)",
    volume = "71",
    pages = "2493--2544",
    journal = "Journal of Finance",
    issn = "0022-1082",
    publisher = "Wiley-Blackwell",
    number = "6",

    }

    TY - JOUR

    T1 - Misspecified Recovery

    AU - Borovicka, Jaroslav

    AU - Hansen, Lars Peter

    AU - Scheinkman, JosÉ A.

    PY - 2016/12/1

    Y1 - 2016/12/1

    N2 - Asset prices contain information about the probability distribution of future states and the stochastic discounting of those states as used by investors. To better understand the challenge in distinguishing investors' beliefs from risk-adjusted discounting, we use Perron–Frobenius Theory to isolate a positive martingale component of the stochastic discount factor process. This component recovers a probability measure that absorbs long-term risk adjustments. When the martingale is not degenerate, surmising that this recovered probability captures investors' beliefs distorts inference about risk-return tradeoffs. Stochastic discount factors in many structural models of asset prices have empirically relevant martingale components.

    AB - Asset prices contain information about the probability distribution of future states and the stochastic discounting of those states as used by investors. To better understand the challenge in distinguishing investors' beliefs from risk-adjusted discounting, we use Perron–Frobenius Theory to isolate a positive martingale component of the stochastic discount factor process. This component recovers a probability measure that absorbs long-term risk adjustments. When the martingale is not degenerate, surmising that this recovered probability captures investors' beliefs distorts inference about risk-return tradeoffs. Stochastic discount factors in many structural models of asset prices have empirically relevant martingale components.

    UR - http://www.scopus.com/inward/record.url?scp=84995624280&partnerID=8YFLogxK

    UR - http://www.scopus.com/inward/citedby.url?scp=84995624280&partnerID=8YFLogxK

    U2 - 10.1111/jofi.12404

    DO - 10.1111/jofi.12404

    M3 - Article

    VL - 71

    SP - 2493

    EP - 2544

    JO - Journal of Finance

    JF - Journal of Finance

    SN - 0022-1082

    IS - 6

    ER -