Production-Based Measures of Risk for Asset Pricing

Abstract

A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers' first-order conditions. The marginal rate of transformation implies a novel macro-factor asset pricing model that does a reasonable job explaining the cross-sectional variation in average stock returns with plausible parameter values. Using a exible representation of firms' production technology, producers' ability to transform output across states of nature is estimated to be high, in contrast with what is typically assumed in standard aggregate representations of firms' production technology.

Keywords: Production-Based Asset Pricing, Production Under Uncertainty, Cross-Sectional Asset Pricing, Marginal Rate of Transformation

JEL Classification: E23, E44, G1, G12