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Cost minimization and the stochastic discount factor

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  • Robert Chambers
  • John Quiggin

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. Copyright Springer Science+Business Media, LLC 2010

Suggested Citation

  • Robert Chambers & John Quiggin, 2010. "Cost minimization and the stochastic discount factor," Annals of Operations Research, Springer, vol. 176(1), pages 349-368, April.
    • Handle: RePEc:spr:annopr:v:176:y:2010:i:1:p:349-368:10.1007/s10479-008-0469-0
    DOI: 10.1007/s10479-008-0469-0
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    References listed on IDEAS

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