Essays on Nonparametric Estimation of Asset Pricing Models
This thesis studies the use of nonparametric econometric methods to reconcile the empirical behaviour of financial asset prices with theoretical valuation models. The confrontation of economic theory with asset price data requires various functional form assumptions about the preferences and beliefs of investors. Nonparametric methods provide a flexible class of models that can prevent misspecification of agents’ utility functions or the distribution of asset returns. Evidence for potential nonlinearity is seen in the presence of non-Gaussian distributions and excessive volatility of stock returns, or non-monotonic stochastic discount factors in option prices. More robust model specifications are therefore likely to contribute to risk management and return predictability, and lend credibility to economists’ assertions. Each of the chapters in this thesis relaxes certain functional form assumptions that seem most important for understanding certain asset price data. Chapter 1 focuses on the state-price density in option prices, which confounds the nonlinearity in both the preferences and the beliefs of investors. To understand both sources of nonlinearity in equity prices, Chapter 2 introduces a semiparametric generalization of the standard representative agent consumption-based asset pricing model. Chapter 3 returns to option prices to understand the relative importance of changes in the distribution of returns and in the shape of the pricing kernel. More specifically, Chapter 1 studies the use of noisy high-frequency data to estimate the time-varying state-price density implicit in European option prices. A dynamic kernel estimator of the conditional pricing function and its derivatives is proposed that can be used for model-free risk measurement. Infill asymptotic theory is derived that applies when the pricing function is either smoothly varying or driven by diffusive state variables. Trading times and moneyness levels are modelled by marked point processes to capture intraday trading patterns. A simulation study investigates the performance of the estimator using an iterated plug-in bandwidth in various scenarios. Empirical results using S&P 500 E-mini European option quotes finds significant time-variation at intraday frequencies. An application towards delta- and minimum variance-hedging further illustrates the use of the estimator. Chapter 2 proposes a semiparametric asset pricing model to measure how consumption and dividend policies depend on unobserved state variables, such as economic uncertainty and risk aversion. Under a flexible specification of the stochastic discount factor, the state variables are recovered from cross-sections of asset prices and volatility proxies, and the shape of the policy functions is identified from the pricing functions. The model leads to closed-form price-dividend ratios under polynomial approximations of the unknown functions and affine state variable dynamics. In the empirical application uncertainty and risk aversion are separately identified from size-sorted stock portfolios exploiting the heterogeneous impact of uncertainty on dividend policy across small and large firms. I find an asymmetric and convex response in consumption (-) and dividend growth (+) towards uncertainty shocks, which together with moderate uncertainty aversion, can generate large leverage effects and divergence between macroeconomic and stock market volatility. Chapter 3 studies the nonparametric identification and estimation of projected pricing kernels implicit in the pricing of options, the underlying asset, and a riskfree bond. The sieve minimum-distance estimator based on conditional moment restrictions avoids the need to compute ratios of estimated risk-neutral and physical densities, and leads to stable estimates even in regions with low probability mass. The conditional empirical likelihood (CEL) variant of the estimator is used to extract implied densities that satisfy the pricing restrictions while incorporating the forwardlooking information from option prices. Moreover, I introduce density combinations in the CEL framework to measure the relative importance of changes in the physical return distribution and in the pricing kernel. The nonlinear dynamic pricing kernels can be used to understand return predictability, and provide model-free quantities that can be compared against those implied by structural asset pricing models.