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RFS Advance Access published online on November 20, 2007
Review of Financial Studies, doi:10.1093/rfs/hhm053
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© The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Conditioning Information and Variance Bounds on Pricing Kernels with Higher- Order Moments: Theory and Evidence

Fousseni Chabi-Yo
Financial Markets Department, Bank of Canada

Address correspondence to Fousseni Chabi-Yo, Financial Markets Department, Bank of Canada, 234 Wellington, Ottawa, Ontario K1A 0G9, Canada, telephone: (613) 782-7735, or e-mail: fchabiyo{at}bankofcanada.ca.

JEL Classification: G12, G13, C61


  Abstract

We develop a strategy for utilizing higher moments, variance risk premia, and conditioning information efficiently, and hence improve on the variance bounds computed by Hansen and Jagannathan (1991); Gallant, Hansen, and Tauchen (1990); and Bekaert and Liu (2004). Our bounds reach existing bounds when nonlinearities in returns are not priced. We also use higher moments, variance risk premia, and conditioning information to provide distance measures that improve on the Hansen and Jagannathan (1997) distance measure. Empirical results indicate that when accounting for the impact of higher moments and variance risk premia, the existing pricing kernels have difficulty in explaining returns on the assets and derivatives.

I thank Matthew Spiegel (the Executive Editor) and Yacine Ait Sahalia (the Editor). I am grateful to Geert Bekaert, René Garcia, Raymond Kan, Jun Liu, and Eric Renault for help or suggestions. An anonymous referee provided extensive guidance, comments, and insights. This paper was presented at the 2005 Midwest Finance Association; the 2005 Econometric Society World Congress in London, England; the 2005 Northern Finance Association; and the 2005 Financial Management Association Annual Meeting in Chicago. I also thank CIRANO for making their data available. The views expressed in this paper are those of the author. No responsibility for them should be attributed to the Bank of Canada. Any remaining errors are solely the author's responsibility.


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