Transaction Costs and the Stochastic Discount Factor

Abstract

Trading costs change which characteristics the stochastic discount factor (SDF) prices, not only its implementability. We embed stock-specific costs in the no-arbitrage condition that identifies a nonlinear SDF, estimated by adversarial networks on U.S. equities. Cost-awareness raises the out-of-sample cross-sectional R^2 by more than half in every cost specification, shifting exposure from high-turnover signals toward stable fundamentals. Pricing and implementation gains come apart under mild frictions and tight position limits. Absorbed anomalies are largely limits-to-arbitrage signals that do not survive their own trading costs. Price impact scales with wealth, so only the cost-aware kernel is tradable at institutional capacity.

Download

SSRN Preprint

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}
}