Pricing Kernels and Stochastic Discount Factors

In this entry we characterize pricing kernels or stochastic discount factors that are used to represent valuation operators in dynamic stochastic economies. A kernel is commonly-used mathematical term used to represent an operator. The term stochastic discount factor extends concepts from economics and finance to include adjustments for risk. As we will see, there is a tight connection between the two terms. The terms pricing kernel and stochastic discount factor are often used interchangeably. After deriving convenient representations for prices, we provide several examples of stochastic discount factors and discuss econometric methods for estimation and testing of asset pricing models that restrict the stochastic discount factors.