Structural Breaks in the Variance Process and the Pricing Kernel Puzzle
Authors: Tobias Sichert (Goethe University)
Title: Structural Breaks in the Variance Process and the Pricing Kernel Puzzle
Abstract: This paper addresses the empirical puzzle whether the pricing kernel derived from option prices is U-shaped or S-shaped. I argue that the latter result stems from a structural break in the data generating process. In the sample period from 1992-2015 I identify five periods with different variance regimes, that have either high or low variance. Conditioning on the regime, the U-shaped pricing kernel is always obtained. The results are robust to numerous changes in the methodology. Furthermore, I discuss several implications for asset pricing.