The Pricing Kernel Puzzle in Forward Looking Data
33 Pages Posted: 7 Mar 2016 Last revised: 22 Aug 2016
Date Written: August 19, 2016
The pricing kernel puzzle concerns the locally increasing empirical pricing kernel, which is inconsistent with a risk-averse representative investor in a single period, single state variable setting. Some recent papers worry that the puzzle is caused simply by the mismatch of backward looking subjective and forward looking risk-neutral distributions of index returns. By using a novel test and forward looking information only, we generally confirm the existence of a u-shaped pricing kernel puzzle in the S&P 500 options data. The evidence is weaker for tests against an alternative with a risk-neutral investor and for longer horizons.
Keywords: Pricing Kernel, Option Pricing, Forward Looking Data
JEL Classification: G12, G13
Suggested Citation: Suggested Citation