Testing Market Efficiency With the Pricing Kernel

European Journal of Finance, 2019

Swiss Finance Institute Research Paper No. 19-77

45 Pages Posted: 1 Aug 2019 Last revised: 2 Jan 2020

See all articles by Giovanni Barone-Adesi

Giovanni Barone-Adesi

University of Lugano; Swiss Finance Institute

Carlo Sala

ESADE Business School

Date Written: January 30, 2019


Market efficiency and the pricing kernel are closely related. A non-monotonic decreasing pricing kernel implies the existence of a trading strategy in contingent claims that stochastically dominates a direct investment in the market. Moreover, a market is assumed to be efficient only if no dominating strategies exist. Empirically, many studies of the pricing kernel find non-monotonicity, apparently ruling out market efficiency. However, these results are often unreliable, because the pricing measures of the pricing kernel are estimated using differing filtration sets. We show this effect both theoretically and empirically, and we discuss recent approaches in the literature for achieving more reliable estimates of the pricing kernel, potentially leading to better tests of market efficiency.

Keywords: market information; market efficiency; pricing kernel; fundamental theorems of asset pricing; dominating trading strategies

JEL Classification: G12; G13; G14

Suggested Citation

Barone-Adesi, Giovanni and Sala, Carlo, Testing Market Efficiency With the Pricing Kernel (January 30, 2019). European Journal of Finance, 2019, Swiss Finance Institute Research Paper No. 19-77, Available at SSRN: https://ssrn.com/abstract=3428288

Giovanni Barone-Adesi

University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Swiss Finance Institute

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

Carlo Sala (Contact Author)

ESADE Business School ( email )

Avenida de Torreblanca 59
Barcelona, Barcelona 08172

HOME PAGE: http://www.people.usi.ch/salaca

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