Consumption Based Asset Pricing Models: Theory

Abstract

The essential element in modern asset pricing theory is a positive random variable called the stochastic discount factor (SDF). This object allows one to price any payoff stream. Its existence is implied by the absence of arbitrage opportunities. Consumption-based asset pricing models link the SDF to the marginal utility growth of investors and in turn to observable economic variables|and in doing so, they provide empirical content to asset pricing theory. This entry discusses this class of models.