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Option market trading activity and the estimation of the pricing kernel: A Bayesian approach
- Source :
- Journal of Econometrics. 216:430-449
- Publication Year :
- 2020
- Publisher :
- Elsevier BV, 2020.
-
Abstract
- We propose a nonparametric Bayesian approach for the estimation of the pricing kernel. Historical stock returns and option market data are combined through the Dirichlet Process (DP) to construct an option-adjusted physical measure. The precision parameter of the DP process is calibrated to the amount of trading activity in deep-out-of-the-money options. We use the option-adjusted physical measure to construct an option-adjusted pricing kernel. An empirical investigation on the S&P 500 Index from 2002 to 2015 shows that the option-adjusted pricing kernel is consistently monotonically decreasing, regardless of the level of volatility, thus providing an explanation to the well known U-shaped pricing kernel puzzle.
Details
- ISSN :
- 03044076
- Volume :
- 216
- Database :
- OpenAIRE
- Journal :
- Journal of Econometrics
- Accession number :
- edsair.doi...........9a21faadd0be023d87fe4655c269bb83