A Dynamic Equilibrium Model for U-Shaped Pricing Kernels

Quantitative Finance, 2017

39 Pages Posted: 11 Feb 2017 Last revised: 30 Jan 2018

Akira Yamazaki

Hosei University - Graduate School of Business Administration

Date Written: August 12, 2017


This paper proposes a dynamic equilibrium model that can provide a unified explanation for the stylized facts observed in stock index markets such as the fat tails of risk-neutral return distribution relative to physical distribution, negative expected returns on deep OTM call options, and negative realized variance risk premiums. In particular, we focus on the U-shaped pricing kernel against the stock index return, which is closely related to the negative call returns. We assume that the stock index return follows the time-changed Levy process and that a representative investor has power utility over the aggregate consumption that forms a linear regression of the stock index return and its stochastic activity rate. This model offers a macroeconomic interpretation of the stylized facts from the perspective of the sensitivity of the activity rate and stock index return on the aggregate consumption as well as the investor's risk aversion.

Keywords: stock index, U-shaped pricing kernel, stochastic activity rate, aggregate consumption, physical distribution, risk-neutral distribution, realized variance

JEL Classification: G12, E43, D51

Suggested Citation

Yamazaki, Akira, A Dynamic Equilibrium Model for U-Shaped Pricing Kernels (August 12, 2017). Quantitative Finance, 2017. Available at SSRN: https://ssrn.com/abstract=2915091 or http://dx.doi.org/10.2139/ssrn.2915091

Akira Yamazaki (Contact Author)

Hosei University - Graduate School of Business Administration ( email )


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