Returns of claims on the upside and the viability of U-shaped pricing kernels
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.
Year of publication: |
2010
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Authors: | Bakshi, Gurdip ; Madan, Dilip ; Panayotov, George |
Published in: |
Journal of Financial Economics. - Elsevier, ISSN 0304-405X. - Vol. 97.2010, 1, p. 130-154
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Publisher: |
Elsevier |
Keywords: | U-shaped pricing kernels Claims on the upside Monotonically declining pricing kernels Expected returns Negative average option returns Short-selling Heterogeneity in beliefs |
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