### Abstract

We answer this question by comparing te risk-neutral density estimated in complete markets from cross-section of S&P 500 option prices to the risk-neutral density inferred from the time series density of the S&P 500 index. If investors are risk-averse, the latter density is different from the actual density that could be inferred from the time series of S&P 500 returns. Naturally, the observed asset returns do not follow the risk-neutral dynamics, which are therefore not directly observable. In contrast to the existing literature, we avoid making any assumptions on investors' preferences, by comparing two risk-adjusted densities, rather than a risk-adjusted density from option prices to an unadjusted density from index returns. Our only maintained hypothesis is a one-factor structure for the S&P 500 returns. We propose a new method, based on an empirical Girsanov's change of measure, to identify the risk-neutral density from the observed unadjusted index returns. We design four different tests of the null hypothesis that the S&P 500 options are efficiently priced given the S&P 500 index dynamics, and reject it. By adding a jump component to the index dynamics, we are able to partly reconcile the differences between the index and option-implied risk-neutral densities, and propose a peso-problem interpretation of this evidence.

Original language | English (US) |
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Pages (from-to) | 67-110 |

Number of pages | 44 |

Journal | Journal of Econometrics |

Volume | 102 |

Issue number | 1 |

DOIs | |

State | Published - May 1 2001 |

### All Science Journal Classification (ASJC) codes

- Economics and Econometrics

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## Cite this

*Journal of Econometrics*,

*102*(1), 67-110. https://doi.org/10.1016/S0304-4076(00)00091-9