Volatility and the Pricing Kernel

Category: Finance Seminar
When: 21 Juni 2022
, 12:00
 - 13:15
Where: online

We show empirically that negative stock market returns are significantly more painful to investors when they occur in periods of low volatility, which is reflected in a steeper pricing kernel. In contrast, popular asset pricing theories imply that the pricing of stock market risk does not vary with volatility, or that it moves in the opposite direction. We show that this counterfactual pricing kernel behavior results from the assumption that volatility and the pricing kernel are driven by common state variables, which in turn is necessary to rationalize the level and predictability of stock market returns in the models. We propose a simple model that rationalizes our empirical finding and the existing fact that shocks to expected stock market volatility are unpriced.