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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26919
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| Title: | Empirical pricing kernels |
| Authors: | Rosenberg, Joshua V.
Engle, Robert F. |
| Issue Date: | Jul-2000 |
| Series/Report no.: | FIN-98-030 |
| Abstract: | This paper investigates the empirical characteristics of investor risk
aversion over equity return states by estimating a time-varying pricing
kernel, which is referred to as the empirical pricing kernel (EPK). The
empirical pricing kernel is the preference function that rationalizes a
contemporaneous cross-section of asset prices, given a forecast payoff
probability density. We estimate the EPK on a monthly basis from 1991 to
1995 using S&P500 index option data and a stochastic volatility
model for the S&P500 return process. We find substantial evidence of
time-varying risk aversion over S&P500 return states. In addition,
we find that empirical risk aversion over S&P500 return states is
linked to business conditions; the level of risk aversion is positively
correlated with indicators of recession and negatively correlated with
indicators of expansion. An option hedging methodology is developed to
test the predictive information in the empirical pricing kernel and its
associated state probability model. Hedging performance is significantly
improved using hedge ratios based on a time-varying pricing kernel
rather than a time-invariant pricing kernel. |
| URI: | http://hdl.handle.net/2451/26919 |
| Appears in Collections: | Economics Working Papers
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