Returns of claims on the upside and the viability of U-shaped pricing kernels

Gurdip Bakshi, Dilip Madan and George Panayotov

Journal of Financial Economics, 2010, vol. 97, issue 1, 130-154

Abstract: When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing region of the kernel. Using returns of (i) S&P 500 index calls, (ii) calls on major international equity indexes, (iii) digital calls, (iv) upside variance contracts, and (v) a theoretical construct that we denote as kernel call, we find broad support for the implications of U-shaped pricing kernels. A possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short-selling.

Keywords: U-shaped; pricing; kernels; Claims; on; the; upside; Monotonically; declining; pricing; kernels; Expected; returns; Negative; average; option; returns; Short-selling; Heterogeneity; in; beliefs (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (69)

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