Volatility-dependent probability weighting and the dynamics of the pricing kernel puzzle

verfasst von

Maik Dierkes, Jan Krupski, Sebastian Schroen, Philipp Sibbertsen

Abstract

In order to estimate volatility-dependent probability weighting functions, we obtain risk neutral and physical densities from the Pan (J Financ Econ 63(1):3–50, 2002. doi.org/10.1016/S0304-405X(01)00088-5) stochastic volatility and jumps model. Across volatility levels, we find pronounced inverse S-shapes, i.e. small probabilities are overweighted, and probability weighting almost monotonically increases in volatility, indicating higher skewness preferences and crash aversion in volatile market environments. Moreover, by estimating probabilistic risk attitudes, equivalent to the share of risk aversion related to probability weighting, we shed further light on the pricing kernel puzzle. While pricing kernels estimated from the Pan (J Financ Econ 63(1):3–50, 2002. doi.org/10.1016/S0304-405X(01)00088-5) model display the typical U-shape as documented in the literature, pricing kernels—net of probability weighting—are strictly monotonically decreasing and thus in line with economic theory. Equivalently, we find risk aversion to be positive across wealth levels. Our results are robust to alternative maturities, wealth percentiles, alternative functional forms, a nonparametric empirical setting and variations of the Pan (J Financ Econ 63(1):3–50, 2002. doi.org/10.1016/S0304-405X(01)00088-5) coefficient estimates.

Organisationseinheit(en)

Institut für Banken und Finanzierung
Institut für Statistik

Typ

Artikel

Journal

Review of derivatives research

Band

Seiten

1-35

Anzahl der Seiten

ISSN

1380-6645

Publikationsdatum

04.2024

Publikationsstatus

Veröffentlicht

Peer-reviewed

ASJC Scopus Sachgebiete

Volkswirtschaftslehre, Ökonometrie und Finanzen (sonstige), Finanzwesen

Elektronische Version(en)

https://doi.org/10.1007/s11147-023-09197-3 (Zugang: Offen)

BibTeX

@article{730203177f6f4b6da07a10aed5ea6657,
title = "Volatility-dependent probability weighting and the dynamics of the pricing kernel puzzle",
abstract = "In order to estimate volatility-dependent probability weighting functions, we obtain risk neutral and physical densities from the Pan (J Financ Econ 63(1):3–50, 2002. https://doi.org/10.1016/S0304-405X(01)00088-5) stochastic volatility and jumps model. Across volatility levels, we find pronounced inverse S-shapes, i.e. small probabilities are overweighted, and probability weighting almost monotonically increases in volatility, indicating higher skewness preferences and crash aversion in volatile market environments. Moreover, by estimating probabilistic risk attitudes, equivalent to the share of risk aversion related to probability weighting, we shed further light on the pricing kernel puzzle. While pricing kernels estimated from the Pan (J Financ Econ 63(1):3–50, 2002. https://doi.org/10.1016/S0304-405X(01)00088-5) model display the typical U-shape as documented in the literature, pricing kernels—net of probability weighting—are strictly monotonically decreasing and thus in line with economic theory. Equivalently, we find risk aversion to be positive across wealth levels. Our results are robust to alternative maturities, wealth percentiles, alternative functional forms, a nonparametric empirical setting and variations of the Pan (J Financ Econ 63(1):3–50, 2002. https://doi.org/10.1016/S0304-405X(01)00088-5) coefficient estimates.",
keywords = "Pricing kernel puzzle, Probability weighting, Risk preferences, Volatility, G41, G11, G14",
author = "Maik Dierkes and Jan Krupski and Sebastian Schroen and Philipp Sibbertsen",
note = "Open Access funding enabled and organized by Projekt DEAL.",
year = "2024",
month = apr,
doi = "10.1007/s11147-023-09197-3",
language = "English",
volume = "27",
pages = "1--35",
journal = "Review of derivatives research",
issn = "1380-6645",
publisher = "Springer New York",
number = "1",
}