55 Pages Posted: 19 Mar 2010
Date Written: August 1, 2009
When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing region of the kernel. Using returns of (i) S&P 500 index calls, (ii) calls on major international equity indexes, (iii) digital calls, (iv) upside variance contracts, and (v) a theoretical construct that we denote as kernel call, we find broad support for the implications of U-shaped pricing kernels. A possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short-selling.
Keywords: U-shaped pricing kernels, claims on the upside, monotonically declining pricing kernels,
JEL Classification: G, G1, G11, G12, G13, C5, D24
Suggested Citation: Suggested Citation
Bakshi, Gurdip and Madan, Dilip B. and Panayotov, George, Returns of Claims on the Upside and the Viability of U-Shaped Pricing Kernels (August 1, 2009). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1570390
By David Bates