A cost-based approach to asset-pricing equilibrium relationships is developed. A cost function induces a stochastic discount factor (pricing kernel) that is a function of random output, prices, and capital stockt. By eliminating opportunities for arbitrage between financial markets and the production technology, firms minimize the current cost of future consumption. The first-order conditions for this cost minimization problem generate the stochastic discount factor. The cost-based approach is dual in nature and determines state-claim prices as the current-period marginal cost of increasing future stochastic output. A cost-based pricing kernel is estimated using annual time-series data on macroeconomic variables and returns data


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