A1492
Title: Transaction costs and the stochastic discount factor
Authors: Daniele Bianchi - Queen Mary University of London (United Kingdom) [presenting]
Abstract: Transaction costs are shown to fundamentally reshape the stochastic discount factor (SDF) by determining which characteristics matter in equilibrium. Using deep neural networks, transaction costs are incorporated directly into robust SDF estimation rather than treated as post-optimization adjustments or arbitrary investment constraints. Transaction cost-aware SDFs yield substantially higher net Sharpe ratios and superior cross-sectional pricing through endogenous portfolio reallocation, including increased diversification, reduced turnover, and lower exposure to costly high-turnover characteristics. These effects persist across sample configurations, market regimes, neural network specifications, and alternative definitions of transaction costs, demonstrating that trading frictions are structural determinants of equilibrium asset prices.
