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Pricing Kernel Monotonicity and Conditional Information

Forthcoming, Review of Financial Studies

59 Pages Posted: 24 Jan 2014 Last revised: 5 Oct 2017

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: October 5, 2017

Abstract

A large literature finds evidence that pricing kernels nonparametrically estimated from option prices and historical returns are not monotonically decreasing in market index returns. We argue that existing estimation methods are inconsistent and propose a new nonparametric estimator of the pricing kernel that reflects the information available to investors who set asset prices. In simulations, the estimator outperforms existing techniques. Our empirical estimates using S&P 500 index option data from 1996 to 2014 and FTSE 100 index option data from 2002 to 2014 suggest that the "pricing kernel puzzle'' is due to flaws in existing estimators rather than a behavioral or economic phenomenon.

Keywords: pricing kernel monotonicity

JEL Classification: G12, G13

Suggested Citation

Linn, Matthew and Shive, Sophie and Shumway, Tyler, Pricing Kernel Monotonicity and Conditional Information (October 5, 2017). Forthcoming, Review of Financial Studies. 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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