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Pricing Kernels with Coskewness and Volatility Risk

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  • Chabi-Yo, Fousseni

    (Ohio State University)

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    Abstract

    I investigate a pricing kernel in which coskewness and the market volatility risk factors are endogenously determined. I show that the price of coskewness and market volatility risk are restricted by investor risk aversion and skewness preference. The risk aversion is estimated to be between two and five and significant. The price of volatility risk ranges from -1.5% to -0.15% per year. Consistent with theory, I find that the pricing kernel is decreasing in the aggregate wealth and increasing in the market volatility. When I project my estimated pricing kernel on a polynomial function of the market return, doing so produces the puzzling behaviors observed in pricing kernel. Using pricing kernels, I examine the sources of the idiosyncratic volatility premium. I find that nonzero risk aversion and firms' non-systematic coskewness determine the premium on idiosyncratic volatility risk. When I control for the non-systematic coskewness factor, I find no significant relation between idiosyncratic volatility and stock expected returns. My results are robust across different sample periods, different measures of market volatility and firm characteristics.

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    File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2008/2008-25-Revise_Final_Paper26112008.pdf
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    Bibliographic Info

    Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2008-25.

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    Date of creation: Mar 2009
    Date of revision:
    Handle: RePEc:ecl:ohidic:2008-25

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    Cited by:
    1. Belén Nieto & Alfonso Novales Cinca & Gonzalo Rubio, 2011. "Why do variance swaps exist?," Documentos del Instituto Complutense de Análisis Económico 2011-06, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.
    2. Belén Nieto & Alfonso Novales Cinca & Gonzalo Rubio, 2011. "Variance Swaps and Intertemporal Asset Pricing," Documentos del Instituto Complutense de Análisis Económico 2011-08, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.

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