Returns of claims on the upside and the viability of U-shaped pricing kernels☆

Bakshi, Gurdip; Madan, Dilip B.; Panayotov, George

doi:10.1016/j.jfineco.2010.03.009

Cited by 177 publications

(87 citation statements)

References 90 publications

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“…The negative expected returns of deep OTM call options on the stock index result from the U-shaped pricing kernels. This affirms the validity of the result in Bakshi et al (2010) even though the model is dynamic in continuous time.…”

Section: Introductionsupporting

confidence: 87%

“…The projection of the pricing kernel (3.17) is defined under the assumption that there exist the density functions of both the physical and risk-neutral distributions. Recent studies such as Bakshi et al (2010) and Christoffersen et al (2013) demonstrated that the projection of the pricing kernel (3.17) depicts U-shape curve, while the classical asset pricing theory concludes that the pricing kernel is monotonically decreasing function with respect to asset returns.…”

Section: Proof Of Propositionmentioning

confidence: 99%

“…More recently, several sophisticated studies as well as theoretical and empirical approaches have considered the U-shaped pricing kernels. For instance, Bakshi et al (2010) investigated the theoretical relation between the expected returns of contingent claims with payout on the upside and the slope of pricing kernels against the index return. They asserted that U-shaped pricing kernels can explain the negative expected returns of deep OTM calls, which is an anomaly found in major index option markets.…”

Section: Introductionmentioning

confidence: 99%

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A dynamic equilibrium model for U-shaped pricing kernels

Yamazaki

2017

Quantitative Finance

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This paper proposes a dynamic equilibrium model that can provide a unified explanation for the stylized facts observed in stock index markets such as the fat tails of riskneutral return distribution relative to physical distribution, negative expected returns on deep OTM call options, and negative realized variance risk premiums. In particular, we focus on the U-shaped pricing kernel against the stock index return, which is closely related to the negative call returns. We assume that the stock index return follows the time-changed Lévy process and that a representative investor has power utility over the aggregate consumption that forms a linear regression of the stock index return and its stochastic activity rate. This model offers a macroeconomic interpretation of the stylized facts from the perspective of the sensitivity of the activity rate and stock index return on the aggregate consumption as well as the investor's risk aversion.

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Section: Introductionsupporting

confidence: 87%

Section: Proof Of Propositionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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A dynamic equilibrium model for U-shaped pricing kernels

Yamazaki

2017

Quantitative Finance

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“…This can be interpreted as evidence of a specific premium for crash risk. Bakshi et al (2010) show that there are also negative returns from holding high strike calls and digitals, and interpret this as evidence for a U-shaped pricing kernel.…”

Section: Introductionmentioning

confidence: 79%

The Skew Risk Premium in the Equity Index Market

2012

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This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent AbstractWe measure the skew risk premium in the equity index market through the skew swap. We argue that just as variance swaps can be used to explore the relationship between the implied variance in option prices and realized variance, so too can skew swaps be used to explore the relationship between the skew in implied volatility and realized skew. Like the variance swap, the skew swap corresponds to a trading strategy, necessary to assess risk premia in a model-free way. We find that almost half of the implied volatility skew can be explained by the skew risk premium. We provide evidence that skew and variance premia are manifestations of the same underlying risk factor in the sense that strategies designed to exploit one of the risk premia but to hedge out the other make zero excess returns. * We are thankful to

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“…Bakshi and Madan (2007) The ideas of Bakshi and Madan (2007) are further developed in Bakshi, Madan, and Panayotov (2010), where 3 groups of investors have power utility with the same risk-aversion parameter (γ =12) and there exists within each cohort a fraction of investors shorting the market (i.e. six different groups of investors).…”

Section: Heterogeneous Investor Modelsmentioning

confidence: 99%