Empirical pricing kernels

Empirical pricing kernels (2001)

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by Joshua V. Rosenberg , Robert F. Engle

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@MISC{Rosenberg01empiricalpricing,
    author = {Joshua V. Rosenberg and Robert F. Engle},
    title = {Empirical pricing kernels },
    year = {2001}
}

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Abstract

This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a time-varying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a stochastic volatility model for the S&P 500 return process. We find that the EPK exhibits countercyclical risk aversion over S&P 500 return states. We also find that hedging performance is significantly improved when we use hedge ratios based the EPK rather than a time-invariant pricing kernel.

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