Smart stochastic discount factors - new publication by Fabio Trojani
In a new study, Professor Fabio Trojani and his co-authors provide a no-arbitrage framework for stochastic discount factors (SDFs) that satisfy convex pricing constraints in markets characterized by a wide range of trading frictions.
They demonstrate a duality relationship connecting minimum dispersion SDFs to portfolio optimization problems with penalty functions directly capturing the underlying frictions. Empirically, they examine how mispricing impacts the SDF’s effectiveness in explaining both cross-sectional and time series variation in asset returns. They find that a minimum-variance SDF, constructed by combining the capital asset pricing model SDF with a portfolio that constrains the mispricing of nonmarket risks, achieves a favorable tradeoff between time series and cross-sectional fit.
The paper "Smart Stochastic Discount Factors" is co-authord with Sofonias Alemu Korsaye and Alberto Quaini, and is forthcoming in Management Science.
May 3, 2026