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The Pricing Kernel Puzzle: Reconciling Index Option Data and Economic Theory

In: Derivative Securities Pricing and Modelling

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  • David P. Brown
  • Jens Carsten Jackwerth

Abstract

The pricing kernel puzzle of Jackwerth (2000) concerns the fact that the empirical pricing kernel implied in S&P 500 index options and index returns is not monotonically decreasing in wealth as standard economic theory would suggest. Thus, those options are currently priced in a way such that any risk-averse investor would increase his/her utility by trading in them. We provide a representative agent model where volatility is a function of a second momentum state variable. This model is capable of generating the empirical patterns in the pricing kernel, albeit only for parameter constellations that are not typically observed in the real world.

Suggested Citation

  • David P. Brown & Jens Carsten Jackwerth, 2012. "The Pricing Kernel Puzzle: Reconciling Index Option Data and Economic Theory," Contemporary Studies in Economic and Financial Analysis, in: Derivative Securities Pricing and Modelling, pages 155-183, Emerald Group Publishing Limited.
    • Handle: RePEc:eme:csefzz:s1569-3759(2012)0000094009
    DOI: 10.1108/S1569-3759(2012)0000094009
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    Cited by:

    1. Maik Dierkes & Jan Krupski & Sebastian Schroen & Philipp Sibbertsen, 2024. "Volatility-dependent probability weighting and the dynamics of the pricing kernel puzzle," Review of Derivatives Research, Springer, vol. 27(1), pages 1-35, April.

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