Stochastic Discount Factors with Cross-Asset Spillovers

The central objective of empirical asset pricing is to identify firm-level signals that explain the cross-section of expected stock returns--whether through exposure to risk factors or persistent mispricing. The dominant paradigm, grounded in the assumption of self-predictability, asserts that a firm's own characteristics forecast its own returns (see, e.g., Cochrane (2011); Harvey et al. (2016)). Complementing this view is a growing literature on cross-predictability--the idea that the characteristics or returns of one asset can help forecast the returns of others (see, e.g., Lo and MacKinlay (1990); Hou (2007); Cohen and Frazzini (2008); Cohen and Lou (2012); Huang et al. (2021, 2022)). A key mechanism underpinning this phenomenon is the presence of lead-lag effects, whereby price movements or information from one firm precede and predict those of related firms. Such effects can stem from staggered information diffusion, peer influence within industries, supply chain linkages, or correlated trading by institutional investors that induces price pressure across related assets. Despite recent methodological advances in modeling cross-stock predictability, several foundational questions remain unresolved. Chief among them is how a mean-variance investor can analytically integrate multiple predictive signals when returns are interconnected across assets. Equally crucial is developing a framework that jointly captures both the relevance of individual signals and the structure of return spillovers--enhancing portfolio performance while preserving interpretability .