Returns of Claims on the Upside and the Viability of U-Shaped Pricing Kernels

56 Pages Posted: 28 Aug 2009 Last revised: 30 Sep 2018

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business; Temple University - Fox School of Business and Management

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

George Panayotov

Hong Kong University of Science & Technology (HKUST)

Multiple version iconThere are 2 versions of this paper

Date Written: July 31, 2009

Abstract

When the pricing kernel is U-shaped, then expected returns of claims with payout on the upside are negative for strikes beyond a threshold, determined by the slope of the U-shaped kernel in its increasing region, and have negative partial derivative with respect to strike in the increasing region of the kernel. Using returns of (i) S&P 500 index calls, (ii) calls on major international equity indexes, (iii) digital calls, (iv) upside variance contracts, and (v) a theoretical construct that we denote as kernel call, we find broad support for the implications of U-shaped pricing kernels. A possible theoretical reconciliation of our empirical findings is explored through a model that accommodates heterogeneity in beliefs about return outcomes and short-selling.

Keywords: U-shaped pricing kernels, claims on the upside, negative call returns, short-selling, heterogeneity in beliefs

JEL Classification: G0, G10, G11, G12, G13, C5, D24

Suggested Citation

Bakshi, Gurdip S. and Bakshi, Gurdip S. and Madan, Dilip B. and Panayotov, George, Returns of Claims on the Upside and the Viability of U-Shaped Pricing Kernels (July 31, 2009). Robert H. Smith School Research Paper No. RHS 06-107, Available at SSRN: https://ssrn.com/abstract=1462543 or http://dx.doi.org/10.2139/ssrn.1462543

Gurdip S. Bakshi (Contact Author)

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

George Panayotov

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong
852-2358-5049 (Phone)
852-2358-1749 (Fax)

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