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Empirical Pricing Kernels and Investor Preferences

  • Kai Detlefsen
  • Wolfgang Härdle
  • Rouslan Moro

This paper analyzes empirical market utility functions and pricing kernels derived from the DAX and DAX option data for three market regimes. A consistent parametric framework of stochastic volatility is used. All empirical market utility functions show a region of risk proclivity that is reproduced by adopting the hypothesis of heterogeneous individual investors whose utility functions have a switching point between bullish and bearish attitudes. The inverse problem of finding the distribution of individual switching points is formulated in the space of stock returns by discretization as a quadratic optimization problem. The resulting distributions vary over time and correspond to different market regimes.

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File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2007-017.pdf
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Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2007-017.

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Length: 37 pages
Date of creation: Apr 2007
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2007-017
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  1. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
  2. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  3. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
  4. Rosenberg, Joshua V. & Engle, Robert F., 2002. "Empirical pricing kernels," Journal of Financial Economics, Elsevier, vol. 64(3), pages 341-372, June.
  5. Pavel Cizek & Wolfgang Karl Härdle & Rafal Weron, 2005. "Statistical Tools for Finance and Insurance," HSC Books, Hugo Steinhaus Center, Wroclaw University of Technology, number hsbook0501.
  6. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
  7. Jens Carsten Jackwerth., 1996. "Recovering Risk Aversion from Option Prices and Realized Returns," Research Program in Finance Working Papers RPF-265, University of California at Berkeley.
  8. Chernov, Mikhail, 2003. "Empirical reverse engineering of the pricing kernel," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 329-364.
  9. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-32, December.
  10. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-51, October.
  11. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  12. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
  13. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  14. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
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