Three Solutions to the Pricing Kernel Puzzle

The pricing kernel puzzle is the observation that the pricing kernelmight be increasing in some range of the market returns. This paperanalyzes the pricing kernel in a nancial market equilibrium. If mar-kets are complete and investors are risk-averse and have common andtrue beliefs, the pricing kernel is a decreasing function of aggregateresources. If at least one of these assumptions is violated, the pricingkernel is not necessarily decreasing. Thus, incomplete markets, risk-seeking behaviour and incorrect beliefs can induce increasing parts inthe pricing kernel and can be seen as potential solutions for the pricingkernel puzzle. We construct examples to illustrate the three explana-tions. We verify the robustness of the explanations under aggregationand compare the phenomena with the ndings in the empirical liter-ature.[...]