@article{6d9f3f11c2614665b867b05b4806c04a,
title = "Option market trading activity and the estimation of the pricing kernel: A Bayesian approach",
abstract = "We propose a nonparametric Bayesian approach for the estimation of the pricing kernel. Historical stock returns and option market data are combined through the Dirichlet Process (DP) to construct an option-adjusted physical measure. The precision parameter of the DP process is calibrated to the amount of trading activity in deep-out-of-the-money options. We use the option-adjusted physical measure to construct an option-adjusted pricing kernel. An empirical investigation on the S\&P 500 Index from 2002 to 2015 shows that the option-adjusted pricing kernel is consistently monotonically decreasing, regardless of the level of volatility, thus providing an explanation to the well known U-shaped pricing kernel puzzle.",
keywords = "Bayesian nonparametric estimation, Dirichlet process, Options, Physical measure, Pricing kernel, Pricing kernel puzzle, S\&P 500 index",
author = "Giovanni Barone-Adesi and Nicola Fusari and Antonietta Mira and C. Sala",
note = "Funding Information: We are grateful to two anonymous referees and to Yacine {\"A}it-Sahalia (the Editor) for comments and suggestions that greatly improved the paper. We would also like to thank Loriano Mancini, Antonio Mele, Eckhard Platen, Francesco Franzoni, Alberto Plazzi, Patrick Gagliardini, Hersh Shefrin, Jer{\^o}me Detemple, David Bates, Stijn Van Nieuwerburgh, Fabio Bellini, Zorana Grbac, and Antonio Rubia and seminar and conference participants at the University of Lugano, University of Lausanne, ESADE Business School, University of Milano Bicocca, 2015 SoFIE Summer School in Brussels, XIV Conference in Quantitative Finance in Parma, SFI Research Day, Istanbul BISP9 conference, EWGCFM conference in Milan, the Barcelona XXV Finance Forum and the Workshop on Parameter Uncertainty with Focus on Recovery for their valuable comments. This work was supported by the SNF 100018-172892 grant and AGAUR - SGR 2017-640 . Appendix A Funding Information: We are grateful to two anonymous referees and to Yacine {\"A}it-Sahalia (the Editor) for comments and suggestions that greatly improved the paper. We would also like to thank Loriano Mancini, Antonio Mele, Eckhard Platen, Francesco Franzoni, Alberto Plazzi, Patrick Gagliardini, Hersh Shefrin, Jer{\^o}me Detemple, David Bates, Stijn Van Nieuwerburgh, Fabio Bellini, Zorana Grbac, and Antonio Rubia and seminar and conference participants at the University of Lugano, University of Lausanne, ESADE Business School, University of Milano Bicocca, 2015 SoFIE Summer School in Brussels, XIV Conference in Quantitative Finance in Parma, SFI Research Day, Istanbul BISP9 conference, EWGCFM conference in Milan, the Barcelona XXV Finance Forum and the Workshop on Parameter Uncertainty with Focus on Recovery for their valuable comments. This work was supported by the SNF100018-172892 grant and AGAUR - SGR 2017-640. Publisher Copyright: {\textcopyright} 2019 Elsevier B.V.",
year = "2020",
month = jun,
doi = "10.1016/j.jeconom.2019.11.001",
language = "English",
volume = "216",
pages = "430--449",
journal = "Journal of Econometrics",
issn = "0304-4076",
publisher = "Elsevier B.V.",
number = "2",
}