Pricing Kernel Monotonicity and the Conservativeness of Risk-Neutral Forecasts

Mamiko Yamashita
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Mamiko Yamashita: Osaka School of International Public Policy, the University of Osaka

No 26E008, OSIPP Discussion Paper from Osaka School of International Public Policy, Osaka University

Abstract: This paper studies the relationship between option-implied, risk-neutral forecasts and their real-world counterparts through the lens of stochastic dominance and pricing kernel monotonicity. We show that when the pricing kernel is weakly decreasing in asset payoffs, the real-world distribution first-order stochastically dominates the risk-neutral one, implying that the risk-neutral forecast is more conservative. The ordering is reversed when the pricing kernel is weakly increasing, implying that risk-neutral forecasts may be more optimistic rather than conservative. We further show that this monotonicity is closely linked to the dependence between asset payoffs and aggregate consumption. Our results provide a new perspective on the pricing kernel puzzle, an empirical finding that pricing kernels for major market indices are often non-monotonic. Our results, together with the pricing kernel puzzle, suggest that the commonly held belief in the conservativeness of risk-neutral forecasts is not generally warranted, even for broad market indices.

Keywords: Asset Pricing; Risk Management; Pricing Kernel Puzzle; Stochastic Dominance (search for similar items in EconPapers)
JEL-codes: G12 G13 G32 (search for similar items in EconPapers)
Pages: 21pages
Date: 2026-05
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