Pricing Kernel Monotonicity and Conditional Information

50 Pages Posted: 24 Jan 2014 Last revised: 5 Aug 2015

Matthew Linn

Isenberg School of Management, University of Massachusetts

Sophie Shive

University of Notre Dame - Department of Finance

Tyler Shumway

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business

Date Written: August 2, 2015

Abstract

A large literature finds evidence that pricing kernels estimated nonparametrically from option prices and historical returns are not monotonically decreasing in market index returns. We propose a new nonparametric estimator of the pricing kernel that reflects the information available to investors who set option prices. In simulations, the estimator outperforms current techniques. Our empirical estimates using S&P 500 index option data from 1996-2012 and FTSE 100 index option data from 2002-2013 suggest that the "pricing kernel puzzle'' is a byproduct of econometric technique rather than a behavioral or economic phenomenon.

Suggested Citation

Linn, Matthew and Shive, Sophie and Shumway, Tyler, Pricing Kernel Monotonicity and Conditional Information (August 2, 2015). Available at SSRN: https://ssrn.com/abstract=2383527 or http://dx.doi.org/10.2139/ssrn.2383527

Matthew Linn

Isenberg School of Management, University of Massachusetts ( email )

Amherst, MA 01003
United States

Sophie Shive

University of Notre Dame - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

Tyler Shumway (Contact Author)

University of Michigan at Ann Arbor, The Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4129 (Phone)
734-936-0274 (Fax)

HOME PAGE: http://www.umich.edu/~shumway

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