An Agnostic and Practically Useful Estimator of the Stochastic Discount Factor

Abstract

We propose an estimator for the stochastic discount factor (SDF) which is agnostic because it does not require macroeconomic proxies or preference assumptions. It depends only on observed asset returns. Nonetheless, it is immune to the form of the multivariate return distribution, including the distribution’s factor structure. Putting our estimator to work, we find that a unique positive SDF prices all U.S. asset classes and satisfies the Hansen/Jagannathan variance bound. In contrast, the Chinese and Indian equity markets do not share the same SDF and hence do not seem to be integrated.