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Pricing Kernel Monotonicity and the Conservativeness of Risk-Neutral Forecasts

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  • Mamiko Yamashita

    (Osaka School of International Public Policy, the University of Osaka)

Abstract

This paper studies the relationship between option-implied, risk-neutral forecasts and their real-world counterparts through the lens of stochastic dominance and pricing kernel monotonicity. We show that when the pricing kernel is weakly decreasing in asset payoffs, the real-world distribution first-order stochastically dominates the risk-neutral one, implying that the risk-neutral forecast is more conservative. The ordering is reversed when the pricing kernel is weakly increasing, implying that risk-neutral forecasts may be more optimistic rather than conservative. We further show that this monotonicity is closely linked to the dependence between asset payoffs and aggregate consumption. Our results provide a new perspective on the pricing kernel puzzle, an empirical finding that pricing kernels for major market indices are often non-monotonic. Our results, together with the pricing kernel puzzle, suggest that the commonly held belief in the conservativeness of risk-neutral forecasts is not generally warranted, even for broad market indices.

Suggested Citation

  • Mamiko Yamashita, 2026. "Pricing Kernel Monotonicity and the Conservativeness of Risk-Neutral Forecasts," OSIPP Discussion Paper 26E008, Osaka School of International Public Policy, Osaka University.
    • Handle: RePEc:osp:wpaper:26e008
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    File URL: https://www.osipp.osaka-u.ac.jp/archives/DP/2026/DP2026E008.pdf
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    Keywords

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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