Recovery with Unbounded Diffusion Processes. (5th January 2017)

• Record Type: Journal Article
• Authors: Walden, Johan
• Is Part Of: Review of finance. Volume 21:Number 4(2017)
• Page Start: 1403
• Page End: 1444
• Publication Date: 2017-01-05
• Subjects: G12 -- G13; Recovery theorem -- Ross recovery -- Asset pricing; Finance -- Europe -- Periodicals; Financiën; Finance; Periodicals; 332.09405
• DOI: 10.1093/rof/rfw068
• Languages: English
• ISSNs: 1572-3097

Abstract

Abstract: We analyze the problem of recovering the pricing kernel and real probability distribution from observed option prices, when the state variable is an unbounded diffusion process. We derive necessary and sufficient conditions for recovery. In the general case, these conditions depend on the properties of the diffusion process, but not on the pricing kernel. We also show that the same conditions determine whether recovery works in practice, when the continuous problem is approximated on a bounded or discrete domain without further specification of boundary conditions. Altogether, our results suggest that recovery is possible for many interesting diffusion processes on unbounded domains.