Three Solutions to the Pricing Kernel Puzzle

Review of Finance, Vol. 17, Issue 3, pp. 1065-1098, 2013

34 Pages Posted: 13 Apr 2010 Last revised: 20 Oct 2013

See all articles by Thorsten Hens

Thorsten Hens

University of Zurich - Department of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute

Christian Reichlin

ETH Zurich; University of Zurich - Department of Banking and Finance

Date Written: January 27, 2012

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).

Keywords: Pricing kernel puzzle, Financial market equilibrium, Risk-seeking behaviour, Biased beliefs, Incomplete markets

JEL Classification: D53, G12

Suggested Citation

Hens, Thorsten and Reichlin, Christian, Three Solutions to the Pricing Kernel Puzzle (January 27, 2012). Review of Finance, Vol. 17, Issue 3, pp. 1065-1098, 2013. Available at SSRN: https://ssrn.com/abstract=1582888 or http://dx.doi.org/10.2139/ssrn.1582888

Thorsten Hens

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 32
Zurich, 8032
Switzerland
+41-44 634 37 06 (Phone)

Norwegian School of Economics and Business Administration (NHH)

Helleveien 30
Bergen, 5045
Norway

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Christian Reichlin (Contact Author)

ETH Zurich ( email )

Rämistrasse 101
CH-8092 Zurich, 8092
Switzerland

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

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