Is the Price Kernel Monotone?

Giovanni Barone-Adesi and Hakim Dall'o
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Giovanni Barone-Adesi: University of Lugano and Swiss Finance Institute
Hakim Dall'o: University of Lugano and Swiss Finance Institute

No 10-03, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We provide a new method to derive the state price density per unit probability based on option prices and GARCH model. We derive the risk neutral distribution using the result in Breeden and Litzenberger (1978) and the historical density adapting the GARCH model of Barone-Adesi, Engle, and Mancini (2008). We take the ratio of these two probabilities in order to describe the shape of the state price density and to evaluate its consistency with economic theory. We find that using a large dataset and introducing non-Gaussian innovations, the pricing kernel puzzle that arises in Jackwerth (2000) disappears both in a single day and over an average of different days with options expiring at the same maturity. We also evaluate the price kernel at the onset of the recent crisis.

Keywords: Pricing kernel; State price density per unit probability; Risk neutral; Historical distribution (search for similar items in EconPapers)
JEL-codes: G12 G13 G14 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2010-01, Revised 2010-04
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1003

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