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Three Solutions to the Pricing Kernel PuzzleThorsten HensDepartment of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute (Zurich Center) Christian ReichlinETH Zurich; University of Zurich - Department of Banking and Finance January 27, 2012 Review of Finance, Forthcoming Abstract: The pricing kernel is an important link between economics and finance. In standard models of financial economics it is proportional to the aggregate marginal utility in the economy. We first how that none of the three standard assumptions (completeness, risk aversion, and correct beliefs) is needed for the pricing kernel to be generally decreasing. If at least one of the three assumptions is violated, the pricing kernel can have increasing parts. We explain the economic principles that lead to an increasing part in the pricing kernel and compare the resulting pricing kernels with the empirical pricing kernel estimated in Jackwerth (2000).
Number of Pages in PDF File: 34 Keywords: Pricing kernel puzzle, Financial market equilibrium, Risk-seeking behaviour, Biased beliefs, Incomplete markets JEL Classification: D53, G12 Accepted Paper SeriesDate posted: April 13, 2010 ; Last revised: June 3, 2012Suggested CitationContact Information
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