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Does the Pricing Kernel Anomaly Reflect Forward Looking Beliefs?

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  • Carlo Sala

    (Swiss Finance Institute at the University of Lugano)

Abstract

Estimating the market's subjective distribution of future returns by means of backward looking historical data leads to uninformative and, at best, partially-conditional measures. What is missing are the investors' forward looking beliefs. This long-lasting problem affects a huge amount of literature and leads to puzzles and suboptimal results. I propose a new flexible and highly informative non-parametric method to estimate a fully-conditional and time varying physical measure. Letting the data speak as much as possible I complete the measure through the informational content of the implied moments of the option prices. The proposed density, a mixture of different sources of information, combines the options forward-looking knowledges with the historical background provided by stock returns thus encoding past, present and future information.The new measure is then used to investigate extensively the pricing kernel monotonicity.

Suggested Citation

  • Carlo Sala, 2015. "Does the Pricing Kernel Anomaly Reflect Forward Looking Beliefs?," Swiss Finance Institute Research Paper Series 15-66, Swiss Finance Institute, revised Feb 2016.
    • Handle: RePEc:chf:rpseri:rp1566
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    File URL: http://ssrn.com/abstract=2720180
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    Cited by:

    1. Horatio Cuesdeanu & Jens Carsten Jackwerth, 2018. "The pricing kernel puzzle: survey and outlook," Annals of Finance, Springer, vol. 14(3), pages 289-329, August.

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