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Option Pricing Kernels and the ICAPM

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  • Brennan, Michael J
  • LIU, XIAOQUAN
  • Xia, Yihong
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    Abstract

    We estimate the parameters of pricing kernels that depend on both aggregate wealth and state variables that describe the investment opportunity set, using FTSE 100 and S&P 500 index option returns as the returns to be priced. The coefficients of the state variables are highly significant and remarkably consistent across specifications of the pricing kernal, and across the two markets. The results provided further strong evidence, which is consistent with Merton's (1973a) Intertemporal Capital Asset Pricing Model, that state variables in addition to market risk are priced.

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    Bibliographic Info

    Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number qt4d90p8ss.

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    Date of creation: 29 Jun 2005
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    Handle: RePEc:cdl:anderf:qt4d90p8ss

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    Web page: http://www.escholarship.org/repec/anderson_fin/
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    Keywords: option pricing;

    References

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    7. Santa-Clara, Pedro & Yan, Shu, 2004. "Jump and Volatility Risk and Risk Premia: A New Model and Lessons from S&P 500 Options," University of California at Los Angeles, Anderson Graduate School of Management qt5dv8v999, Anderson Graduate School of Management, UCLA.
    8. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.
    9. Fama, Eugene F & French, Kenneth R, 1995. " Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-55, March.
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    19. Liu, Xiaoquan & Shackleton, Mark B. & Taylor, Stephen J. & Xu, Xinzhong, 2007. "Closed-form transformations from risk-neutral to real-world distributions," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1501-1520, May.
    20. Robert R. Bliss & Nikolaos Panigirtzoglou, 2004. "Option-Implied Risk Aversion Estimates," Journal of Finance, American Finance Association, vol. 59(1), pages 407-446, 02.
    21. Ferson, Wayne E. & Foerster, Stephen R., 1994. "Finite sample properties of the generalized method of moments in tests of conditional asset pricing models," Journal of Financial Economics, Elsevier, vol. 36(1), pages 29-55, August.
    22. Michael J. Brennan & Ashley W. Wang & Yihong Xia, 2004. "Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing," Journal of Finance, American Finance Association, vol. 59(4), pages 1743-1776, 08.
    23. Bansal, Ravi & Viswanathan, S, 1993. " No Arbitrage and Arbitrage Pricing: A New Approach," Journal of Finance, American Finance Association, vol. 48(4), pages 1231-62, September.
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