Characterizing the Conditional Pricing Kernel: A New Approach

Hyung Joo Kim
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Hyung Joo Kim: https://www.federalreserve.gov/econres/hyung-joo-kim.htm

No 2026-059, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: I propose a novel method to reliably estimate the conditional pricing kernel by incorporating conditioning variables. The VIX and the term spread are most informative variables for identifying state prices. The conditional kernel estimate exhibits significant time variation: the more favorable market expectations, the higher state prices in negative return states. During bad times, the equity premium implied by the conditional kernel is fully attributable to compensation for left-tail scenarios, in contrast to findings from the unconditional kernel. Lastly, the conditional kernel estimate yields superior out-of-sample option pricing performance compared to the unconditional kernel estimate.

Pages: 57 p.
Date: 2026-08-24
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:103680

DOI: 10.17016/FEDS.2026.059

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