Stochastic Discount Factors (SDFs) and the Equity Premium Puzzle under a power utility specification

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Germán Forero Laverde


This article analyses the stochastic discount factor (SDF) both from the equilibrium perspective, where it appears as a marginal rate of substitution, and from the arbitrage perspective, where it appears as the Radon – Nikodym derivative which allows for a change in the probability measurable space. Its study entails the use of a power utility function, deriving the marginal rate of substitution and the application of the model to Colombian time series. As a result, we confirm the existence of the equity premium puzzle.

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