Stochastic Discount Rates, Productivity Shocks and Capital Asset Pricing

Yajun Peng and Hany Shawky

Review of Quantitative Finance and Accounting, 1999, vol. 12, issue 1, 34 pages

Abstract: This paper develops a production based asset pricing model under the assumption of a stochastic discount rate. By solving Tobin's q explicitly, we first show that productivity shocks are the main source of the time-varying behavior of expected asset returns and then derive an equilibrium relation between asset returns and both the productivity shocks and the growth rate of the marginal productivity of capital. In addition, we use aggregate data to show that over 40 percent of the stock market's annual returns are explained by next year's aggregate productivity shocks and the current year's differential adjustment cost. Our empirical results are consistent with the model's predictions and with earlier research that documents a strong association between ex-post asset returns and the macroeconomy. Copyright 1999 by Kluwer Academic Publishers

Date: 1999
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