Transaction Costs and the Stochastic Discount Factor

Abstract

Transaction costs are structural determinants of the stochastic discount factor (SDF), not merely implementation frictions. We embed stock-specific trading costs into the no-arbitrage condition to identify a nonlinear SDF, estimated via adversarial neural networks across a large cross-section of U.S. equities. The resulting transaction-cost-aware pricing kernel simultaneously improves cross-sectional pricing, mean-variance efficiency, and anomaly absorption. These gains arise from reallocating away from high-turnover signals toward stable fundamentals, producing a taxonomy of implementation-dependent versus cost-invariant risk premia. Our analysis operates at the level of the pricing kernel rather than portfolio optimization and is robust to systematic perturbations to the baseline specification.

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Citation

Bianchi, Daniele, Teng Jiao, and Hao Ma. “Transaction Costs and the Stochastic Discount Factor.” Working paper.

@article{bianchi2025transaction,
  title={Transaction Costs and the Stochastic Discount Factor},
  author={Bianchi, Daniele and Jiao, Teng and Ma, Hao},
  journal={Available at SSRN 5365375},
  year={2025}
}