A Theory of Dissimilarity between Stochastic Discount Factors

64 Pages Posted: 11 Sep 2017 Last revised: 20 Sep 2017

See all articles by Gurdip Bakshi

Gurdip Bakshi

Fox School of Business

Xiaohui Gao Bakshi

Fox School of Business, Temple University

George Panayotov

Hong Kong University of Science & Technology (HKUST)

Date Written: September 19, 2017

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 based on a probability distance metric, is dimensionless, synthesizes features of the risk-neutral distribution of currency returns, and can be extracted from currency option prices. Linking theory to data, our empirical implementation reveals a salient geographical pattern in dissimilarity across 45 pairs of industrialized economies. We compare the dissimilarity between SDFs derived from several international asset pricing models to the empirical analog, offering a new dimension to gauge models.

Keywords: Dissimilarity between SDFs

Suggested Citation

Bakshi, Gurdip S. and Gao, Xiaohui and Panayotov, George, A Theory of Dissimilarity between Stochastic Discount Factors (September 19, 2017). Available at SSRN: https://ssrn.com/abstract=3034434 or http://dx.doi.org/10.2139/ssrn.3034434

Gurdip S. Bakshi

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Xiaohui Gao (Contact Author)

Fox School of Business, Temple University ( email )

Philadelphia, PA 19122
United States

George Panayotov

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong
852-2358-5049 (Phone)
852-2358-1749 (Fax)

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