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Returns of Claims on the Upside and the Viability of U-Shaped Pricing Kernels

55 Pages Posted: 19 Mar 2010  

Gurdip Bakshi

University of Maryland - Robert H. Smith School of Business

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

George Panayotov

Hong Kong University of Science & Technology (HKUST)

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2009

Abstract

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

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

Gurdip S. Bakshi (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-2261 (Phone)
301-314-9157 (Fax)

HOME PAGE: http://scholar.rhsmith.umd.edu/gbakshi/Home?destination=Home

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

George Panayotov

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong
852-2358-5049 (Phone)
852-2358-1749 (Fax)

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