Pricing Kernel Monotonicity and Conditional Information

Abstract

A large literature finds evidence that pricing kernels estimated nonparametrically from option prices and historical returns are not monotonically decreasing in market index returns. We propose a new nonparametric estimator of the pricing kernel that reflects the information available to investors who set option prices. In simulations, the estimator outperforms current techniques. Our empirical estimates using S&P 500 index option data from 1996-2012 and FTSE 100 index option data from 2002-2013 suggest that the “pricing kernel puzzle” is a byproduct of econometric technique rather than a behavioral or economic phenomenon.