A0960
Title: Spanning the achievable stochastic discount factor with asset-pricing trees
Authors: Rasmus Lonn - Erasmus University Rotterdam - Econometric Institute (Netherlands) [presenting]
Anastasija Tetereva - Erasmus University Rotterdam (Netherlands)
Cil Bemelmans - Erasmus University - Econometric Institute (Netherlands)
Abstract: Most cross-sections of asset returns based on a prior study on asset-pricing trees do not span the stochastic discount factor (SDF) when transaction costs are incorporated, even though their performance ignoring transaction costs indicates they do. The results are similar to those found for other factor models in a recent study. Including transaction costs in the cross-validation stage of estimating asset-pricing tree portfolios, based on the data-driven portfolios as per a previous study, improves their ability to span the achievable SDF by limiting turnover. Applying the no-trade region to smooth trading activities within the portfolios improves their net Sharpe ratios further. The findings indicate that ignoring transaction costs in the cross-validation stage underestimates the optimal scale of shrinkage parameters, and biases results towards cross-sections containing factors that rebalance more often. The study uses CRSP data from 1964 to 2016 for all US stocks.
