infonet-economy

There is strong empirical evidence that the pricing kernel is U-shaped, which provides a way to explain the substantial coskewness premium. Existing studies typically use a polynomial approximation of the pricing kernel. Problematically, these polynomials have, in most cases, increasing parts by construction. Therefore, it is not clear whether the increasing parts are an artifact of the chosen functional form. Taking this concept into consideration, this paper shows that pricing kernels, as estimated by the generalized method of moments on equity data, are still U-shaped and that the increasing part is not a statistical artifact. This conclusion derives from the fact that the functional form of kernels, which allows for strictly decreasing kernels as well as for kernels with increasing parts, is still U-shaped. These results arise from checking for higher order polynomials, various time horizons, and different functional forms of the kernel.