Option Pricing Kernels and the Icapm

28 Pages Posted: 19 Jul 2006

See all articles by Xiaoquan Liu

Xiaoquan Liu

Essex Business School

Michael J. Brennan

University of California, Los Angeles (UCLA) - Finance Area

Yihong Xia

University of California, Los Angeles (Deceased)

Abstract

We estimate the parameters of pricing kernels that depend on both aggregate wealth and state variables that describe the investment opportunity set, using FTSE 100 and S&P 500 index option returns as the returns to be priced. The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernel, and across the two markets. The results provide further evidence that, consistent with Merton's (1973) Intertemporal Capital Asset Pricing Model, state variables in addition to market risk are priced.

Keywords: pricing kernel, state variables, intertemporal CAPM

JEL Classification: G12

Suggested Citation

Liu, Xiaoquan and Brennan, Michael John and Xia, Yihong, Option Pricing Kernels and the Icapm. EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=917911 or http://dx.doi.org/10.2139/ssrn.917911

Xiaoquan Liu (Contact Author)

Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Michael John Brennan

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825 3587 (Phone)
310-206 8419 (Fax)

Yihong Xia

University of California, Los Angeles (Deceased)

N/A

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