Empirical Pricing Kernels

Posted: 2 Jun 2003

See all articles by Joshua V. Rosenberg

Joshua V. Rosenberg

Federal Reserve Bank of New York

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

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Abstract

This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a time-varying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a stochastic volatility model for the S&P 500 return process. We find that the EPK exhibits counter cyclical risk aversion over S&P 500 return states. We also find that hedging performance is significantly improved when we use hedge ratios based the EPK rather than a time-invariant pricing kernel.

Keywords: Pricing kernels, Risk aversion, Derivatives, Hedging

JEL Classification: G12, G13, C50

Suggested Citation

Rosenberg, Joshua V. and Engle, Robert F., Empirical Pricing Kernels. Journal of Financial Economics, Vol. 64, No. 3, 2002. Available at SSRN: https://ssrn.com/abstract=393020

Joshua V. Rosenberg (Contact Author)

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Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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New York University (NYU) - Department of Finance

Stern School of Business
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National Bureau of Economic Research (NBER)

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