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Is the pricing kernel u-shaped?


Schweri, Urs (2011). Is the pricing kernel u-shaped? NCCR Finrisk Working Paper 732, University of Zurich.

Abstract

There is strong empirical evidence that the pricing kernel is U-shaped, which provides a way to explain the substantial coskewness premium. Existing studies typically use a polynomial approximation of the pricing kernel. Problematically, these polynomials have, in most cases, increasing parts by construction. Therefore, it is not clear whether the increasing parts are an artifact of the chosen functional form. Taking this concept into consideration, this paper shows that pricing kernels, as estimated by the generalized method of moments on equity data, are still U-shaped and that the increasing part is not a statistical artifact. This conclusion derives from the fact that the functional form of kernels, which allows for strictly decreasing kernels as well as for kernels with increasing parts, is still U-shaped. These results arise from checking for higher order polynomials, various time horizons, and different functional forms of the kernel.

There is strong empirical evidence that the pricing kernel is U-shaped, which provides a way to explain the substantial coskewness premium. Existing studies typically use a polynomial approximation of the pricing kernel. Problematically, these polynomials have, in most cases, increasing parts by construction. Therefore, it is not clear whether the increasing parts are an artifact of the chosen functional form. Taking this concept into consideration, this paper shows that pricing kernels, as estimated by the generalized method of moments on equity data, are still U-shaped and that the increasing part is not a statistical artifact. This conclusion derives from the fact that the functional form of kernels, which allows for strictly decreasing kernels as well as for kernels with increasing parts, is still U-shaped. These results arise from checking for higher order polynomials, various time horizons, and different functional forms of the kernel.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2011
Deposited On:09 Feb 2012 11:56
Last Modified:05 Apr 2016 15:24
Series Name:NCCR Finrisk Working Paper
Free access at:Official URL. An embargo period may apply.
Official URL:http://www.zora.uzh.ch/55632/
Related URLs:http://www.nccr-finrisk.uzh.ch/wps.php?action=query&id=732
Other Identification Number:merlin-id:5066
Permanent URL: https://doi.org/10.5167/uzh-55632

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