Journal of Financial Econometrics, 5(4), 2007, 523-559
A. Ronald Gallant
We use purely statistical methods to determine if the pricing kernel is the intertemporal marginal rate of substitution under recursive utility. We introduce a nonparametric Bayesian method that treats the pricing kernel as a latent variable and extracts it and its transition density from payoffs on 24 Fama-French portfolios, on bonds, and on payoffs that use conditioning information available when portfolios are formed. Our priors are formed from an examination of a Bansal-Yaron economy. Using both monthly data and annual data, we find that the data support recursive utility.
This work was supported by National Science Foundation Grant Numbers SES 0438174 (Gallant) SES 0452143 (Hong). We thank Lars Peter Hansen, Christian Gouriéroux, and Michael Pitt for their comments.
Received June 2, 2006; revised June 1, 2007; accepted July 18, 2007