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A Theory of Dissimilarity Between Stochastic Discount Factors

Author

Listed:
  • Gurdip Bakshi

    (Fox School of Business, Temple University, Philadelphia, Pennsylvania 19122)

  • Xiaohui Gao

    (Fox School of Business, Temple University, Philadelphia, Pennsylvania 19122)

  • George Panayotov

    (School of Business and Management, Hong Kong University of Science and Technology, Clearwater Bay, Kowloon, Hong Kong)

Abstract

This paper proposes a measure of dissimilarity between stochastic discount factors (SDFs) in different economies. The SDFs are made comparable using the respective bond prices as the numeraire. The measure is dimensionless, synthesizes features of the risk-neutral moments of excess currency returns, and can be extracted from currency option prices. Linking theory to data, we provide evidence gathered from (i) the cross section of 45 currency option prices, (ii) the time series of currency returns, (iii) estimated SDFs using model-free restrictions, and (iv) structural models in international finance.

Suggested Citation

  • Gurdip Bakshi & Xiaohui Gao & George Panayotov, 2021. "A Theory of Dissimilarity Between Stochastic Discount Factors," Management Science, INFORMS, vol. 67(7), pages 4602-4622, July.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:7:p:4602-4622
    DOI: 10.1287/mnsc.2020.3690
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