Smart Stochastic Discount Factors

Sofonias A. Korsaye, Alberto Quaini and Fabio Trojani
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Sofonias A. Korsaye: University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute
Alberto Quaini: University of Geneva
Fabio Trojani: Swiss Finance Institute; University of Geneva

No 21-51, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We propose a novel no-arbitrage framework, which exploits convex asset pricing constraints to study investors’ marginal utility of wealth or, more generally, Stochastic Discount Factors (SDFs). We establish a duality between minimum dispersion SDFs and penalized portfolio selection problems, building the foundation for characterizing the feasible tradeoffs between a SDF’s pricing accuracy and its comovement with systematic risks. Empirically, a minimum variance CAPM–SDF produces a Pareto optimal tradeoff. This SDF only depends on two distinct risk factors: A traded market factor and a minimum variance excess return that bounds the mispricing of risks unspanned by market shocks.

Keywords: SDF; Convex Pricing Constraints; Minimum Dispersion SDF; Market Frictions; SDF regularization; Arbitrage Pricing Theory (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 73 pages
Date: 2021-07
New Economics Papers: this item is included in nep-cwa, nep-isf and nep-ore
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2151

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