# Financial Markets and Asset Pricing

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## Abstract

Essentially all modern asset pricing models rely on a single fundamental pricing equation according to which the price of an asset follows the relationship where

$${P}_{i,t} = {E}_{t}[{M}_{t+1}{X}_{i,t+1}]$$

(2.1)

*P*_{i, t}is the price of an asset*i*at time*t*,*M*_{t+ 1}is the stochastic discount factor (SDF) and*X*_{i, t+ 1}represents the payoff of asset*i*at*t*+ 1. Payoffs in general can be split up into a future price component (*P*_{i, t+ 1}) and an earning stream (*D*_{i, t+ 1}) such as coupon payments on coupon-bearing bonds or dividends on stocks. Since future payoffs are uncertain, the SDF is used to value the state-contingent possible payoffs of the asset in*t*+ 1 so that the SDF takes the uncertain payoff back to present. But even if the cash flows generated by asset*i*may be known with certainty, the discount factors and future interest rates respectively are uncertain numbers depending on the future state of the economy.## Keywords

Risk Aversion Asset Price Risk Premium Marginal Utility Sharpe Ratio
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

## Copyright information

© Springer-Verlag Berlin Heidelberg 2011