Speaker: Fabio Trojani, University of Geneva
We introduce model-free Smart Stochastic Discount Factors (S–SDFs) minimizing various notions of SDF dispersion, under general convex constraints on non zero pricing errors. S–SDFs can be naturally motivated by market frictions, asymptotic no-arbitrage conditions in an APT framework or a need for SDF regularization. More broadly, we show that they are always supported by a suitable viable economy with transaction costs. Minimum dispersion S–SDFs give rise to new nonparametric bounds for asset pricing models, under weaker assumptions on a model’s ability to price cross-sections of assets. They arise from a simple transformation of the optimal payoff in a dual penalized portfolio problem. We clarify the deep properties of S–SDFs induced by various economically motivated pricing error structures and develop a systematic tractable approach for their empirical analysis. For various APT settings, we demonstrate the improved out-of-sample pricing performance of minimum dispersion S–SDFs, which directly corresponds to highly profitable dual portfolio strategies.