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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26916
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| Title: | Empirical pricing kernels |
| Authors: | Rosenberg, Joshua V.
Engle, Robert F. |
| Issue Date: | Mar-1999 |
| Series/Report no.: | S-DRP-99-01 |
| Abstract: | This paper investigates the empirical characteristics of investor risk
aversion over equity return states by estimating a daily semi-parametric
pricing kernel. The two key features of this estimator are: (1) the
functional form of the pricing kernel is estimated semi-parametrically,
instead of being prespecified and (2) the pricing kernel is re-estimated
on a daily basis, allowing measurement of time-variation in riskaversion
over equity return states. Important empirical findings of the paper
are as follows. Constant relative risk aversion over S&P500 return
states is rejected in favor of a model in which relative risk aversion
is stochastic. Empirical relative risk aversion over equity return
states is found to be positively autocorrelated and positively
correlated with the spread between implied and objective volatilities.
In addition, the constant relative risk aversion (power utility) pricing
kernel is found to underestimate the value of payoffs in large negative
return states. An option hedging methodology is developed as a test of
the predictive information in the empirical pricing kernel and its
associated state probability model. The results of hedging performance
tests for out-of-the-money S&P500 index put options indicate that
time-varying risk aversion over equity return states is an important
factor affecting option prices. |
| URI: | http://hdl.handle.net/2451/26916 |
| Appears in Collections: | Derivatives Research
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