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

Listed author(s):
  • Bakshi, Gurdip
  • Madan, Dilip
  • Panayotov, George
Registered author(s):

    When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing region of the kernel. Using returns of (i) S&P 500 index calls, (ii) calls on major international equity indexes, (iii) digital calls, (iv) upside variance contracts, and (v) a theoretical construct that we denote as kernel call, we find broad support for the implications of U-shaped pricing kernels. A possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short-selling.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0304-405X(10)00052-8
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    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 97 (2010)
    Issue (Month): 1 (July)
    Pages: 130-154

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    Handle: RePEc:eee:jfinec:v:97:y:2010:i:1:p:130-154
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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