Skip to main content
SpringerLink
Log in

Cost minimization and the stochastic discount factor

  • Published:
Annals of Operations Research Aims and scope Submit manuscript

Abstract

It is shown that a cost function subject to internal costs of adjustment induces a stochastic discount factor (pricing kernel) that is a function of random output, input and output prices, existing capital stock, and investment. The only assumption on firm preferences is that they are increasing in current period consumption and future stochastic consumption. This ensures that the firm will always act to minimize current period cost of providing future consumption, and it is the first-order conditions for this cost minimization problem that generate the stochastic discount factor, which itself can be interpreted as the marginal variable cost of varying stochastic output. A cost-based pricing kernel is estimated using annual time-series data on macroeconomic variables and returns data for the S&P 500 and commercial paper.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Campbell, J. Y. (2003). Consumption-based asset pricing. In G. M. Constantinides, M. Harris, & R. M. Stulz (Eds.), Handbook of financial economics. Amsterdam: Elsevier.

    Google Scholar 

  • Campbell, J. Y., Lo, A. W., & MacKinlay, A. C. (1997). The econometrics of financial markets. Princeton: Princeton University Press.

    Google Scholar 

  • Chambers, R. G., & Quiggin, J. (2000). Uncertainty, production, choice, and agency: The state-contingent approach. New York: Cambridge University Press.

    Google Scholar 

  • Chambers, R. G., & Quiggin, J. (2008). Narrowing the no-arbitrage bounds. Journal of Mathematical Economics, 44, 1–14.

    Article  Google Scholar 

  • Chen, N., Roll, R., & Ross, S. A. (1986). Economic forces and the stock market. Journal of Business, 59, 383–403.

    Article  Google Scholar 

  • Clark, S. A. (1993). The valuation problem in arbitrage price theory. Journal of Mathematical Economics, 463–478.

  • Cochrane, J. H. (1991). Production-based asset pricing and the link between stock returns and economic fluctuations. Journal of Finance, 46, 209–237.

    Article  Google Scholar 

  • Cochrane, J. H. (1996). A cross-sectional test of an investment-based asset pricing model. Journal of Political Economy, 104, 572–621.

    Article  Google Scholar 

  • Cochrane, J. H. (2001). Asset pricing. Princeton: Princetion University Press.

    Google Scholar 

  • Duffie, D. (2003). Intertemporal asset-pricing theory. In G. M. Constantinides, M. Harris, & R. M. Stulz (Eds.), Handbook of the economics of finance. Amsterdam: Elsevier.

    Google Scholar 

  • Hamilton, J. (1994). Time-series analysis. Princeton: Princeton University Press.

    Google Scholar 

  • Hansen, L. P. (1982). Large sample properties of generalized method of moments estimators. Econometrica, 50, 1029–1054.

    Article  Google Scholar 

  • Hansen, L. P., & Jagannathan, R. (1991). Implications of security market data for models of dynamic economies. Journal of Political Economy, 99, 225–262.

    Article  Google Scholar 

  • Hansen, L. P., & Jagannathan, R. (1997). Assessing specification errors in stochastic discount factor models. Journal of Finance, 52, 557–590.

    Article  Google Scholar 

  • Hansen, L. P., & Singleton, K. J. (1982). Generalized instrumental variables estimation of nonlinear rational expectations models. Econometrica, 50, 1269–1286.

    Article  Google Scholar 

  • Harrison, J., & Kreps, D. (1979). Martingales and arbitrage in multiperiod securities markets. Journal of Economic Theory, 20, 381–408.

    Article  Google Scholar 

  • Jermann, U. J. (1998). Asset pricing in production economies. Journal of Monetary Economics, 41, 257–275.

    Article  Google Scholar 

  • Luenberger, D. (1969). Optimization by vector-space methods. New York: Wiley.

    Google Scholar 

  • Mehra, R., & Prescott, E. (1985). The equity-premium puzzle. Journal of Monetary Economics, 15, 145–161.

    Article  Google Scholar 

  • Ross, S. A. (1978). A simple approach to the valuation of risky streams. Journal of Business, 51, 453–475.

    Article  Google Scholar 

  • Shiller, R. J. (1982). Consumption, asset markets, and macroeconomic fluctuations. Carnegie-Rochester Series on Public Policy, 17, 203–238.

    Article  Google Scholar 

  • Tallarini, T. D. (2000). Risk-sensitive real-business cycles. Journal of Monetary Economics, 45, 507–532.

    Article  Google Scholar 

  • Working, H. (1953). Hedging reconsidered. Journal of Farm Economics, 35, 544–561.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. University of Maryland, College Park, MD, USA

    Robert G. Chambers

  2. University of Queensland, St. Lucia, QLD, Australia

    John Quiggin

Authors
  1. Robert G. Chambers
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. John Quiggin
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Robert G. Chambers.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Chambers, R.G., Quiggin, J. Cost minimization and the stochastic discount factor. Ann Oper Res 176, 349–368 (2010). https://doi.org/10.1007/s10479-008-0469-0

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10479-008-0469-0

Keywords

Search

Navigation