Ross Recovery under the Tree Model and Its Application to Risk Management

Ross (2015) has shown that real-world distributions can be derived from risk-neutral densities, named the Recovery Theorem, which makes the information embedded in option prices directly accessible to applications such as trading strategies, portfolio optimization and risk management. However, as we have to solve an ill-posed problem in the recovery process, application of the theorem to empirical problems is not straightforward. We propose a new method based on the trinomial tree model. Under the method, in addition to its accuracy and robustness, we can decrease the computational time drastically. We then apply the method to the stock and FX markets. By using the recovered real-world distribution, we create some early warning indicators to predict the future risk events, and show their effectiveness.首都大学東京, 2018-03-25, 修士（経営学）首都大学東