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Conditioning Information and Variance Bounds on Pricing Kernels with Higher- Order Moments: Theory and Evidence

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  • Fousseni Chabi-Yo

Abstract

We develop a strategy for utilizing higher moments, variance risk premia, and conditioning information efficiently, and hence improve on the variance bounds computed by Hansen and Jagannathan (1991); Gallant, Hansen, and Tauchen (1990); and Bekaert and Liu (2004). Our bounds reach existing bounds when nonlinearities in returns are not priced. We also use higher moments, variance risk premia, and conditioning information to provide distance measures that improve on the Hansen and Jagannathan (1997) distance measure. Empirical results indicate that when accounting for the impact of higher moments and variance risk premia, the existing pricing kernels have difficulty in explaining returns on the assets and derivatives. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

Suggested Citation

  • Fousseni Chabi-Yo, 2008. "Conditioning Information and Variance Bounds on Pricing Kernels with Higher- Order Moments: Theory and Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 181-231, January.
    • Handle: RePEc:oup:rfinst:v:21:y:2008:i:1:p:181-231
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    File URL: http://hdl.handle.net/10.1093/rfs/hhm053
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    Cited by:

    1. Lin, Yuehao & Lehnert, Thorsten & Wolff, Christian, 2019. "Skewness risk premium: Theory and empirical evidence," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 174-185.
    2. Peñaranda, Francisco & Sentana, Enrique, 2016. "Duality in mean-variance frontiers with conditioning information," Journal of Empirical Finance, Elsevier, vol. 38(PB), pages 762-785.
    3. Patrick Gagliardini & Diego Ronchetti, 2020. "Comparing Asset Pricing Models by the Conditional Hansen-Jagannathan Distance," Journal of Financial Econometrics, Oxford University Press, vol. 18(2), pages 333-394.
    4. Caio Almeida & René Garcia, 2017. "Economic Implications of Nonlinear Pricing Kernels," Management Science, INFORMS, vol. 63(10), pages 3361-3380, October.
    5. Chang, Bo Young & Christoffersen, Peter & Jacobs, Kris, 2013. "Market skewness risk and the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 107(1), pages 46-68.
    6. Yuewu Xu, 2021. "A new measure of model misspecification with the no-arbitrage constraint: extending the second Hansen–Jagannathan distance," Review of Quantitative Finance and Accounting, Springer, vol. 56(3), pages 917-938, April.
    7. Christoffersen, Peter & Fournier, Mathieu & Jacobs, Kris & Karoui, Mehdi, 2021. "Option-Based Estimation of the Price of Coskewness and Cokurtosis Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 56(1), pages 65-91, February.
    8. Wonnho Choi, 2018. "Consumption-based capital asset pricing models: issues and controversies," Review of Quantitative Finance and Accounting, Springer, vol. 50(1), pages 181-205, January.
    9. Abed Masrorkhah, Sara & Lehnert, Thorsten, 2017. "Press freedom and jumps in stock prices," Economic Systems, Elsevier, vol. 41(1), pages 151-162.
    10. Xu, Yuewu & Yao, Xiangkun, 2019. "Extending the Hansen–Jagannathan distance measure of model misspecification," Finance Research Letters, Elsevier, vol. 29(C), pages 384-392.
    11. Bruno Feunou & Mohammad R Jahan-Parvar & Cédric Okou, 2018. "Downside Variance Risk Premium," Journal of Financial Econometrics, Oxford University Press, vol. 16(3), pages 341-383.
    12. Winston Buckley & Sandun Perera, 2019. "Optimal demand in a mispriced asymmetric Carr–Geman–Madan–Yor (CGMY) economy," Annals of Finance, Springer, vol. 15(3), pages 337-368, September.
    13. Belén Nieto & Alfonso Novales Cinca & Gonzalo Rubio, 2011. "Variance Swaps and Intertemporal Asset Pricing," Documentos de Trabajo del ICAE 2011-08, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.

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