Option portfolio choice under pricing kernel monotonicity

Brendan Beare (San Diego University)
Monday, February 4, 2013 - 2:00pm
Spandauer Strasse 1, Room 23

A recent literature in empirical finance documents the nonmonotone shape of pricing kernel estimates for several major market indices. In this paper we investigate the implications of pricing kernel nonmonotonicity for option portfolio choice. We propose a portfolio selection procedure that aims to deliver superior returns, relative to a direct market investment, by adapting to the shape of the pricing kernel. Numerical implementation of our procedure may be achieved using a multiobjective evolutionary algorithm. We investigate the out-of-sample performance of our portfolio selection procedure using twenty years of data from the market for European put and call options written on the SnP 500 index. Monthly portfolio returns outperform those of a direct market investment.