Presidential Address

The Journal of Finance

John H. Cochrane

President of the American Finance Association 2010

THE JOURNAL OF FINANCE • VOL. LXVI, NO. 4 • AUGUST 2011

Presidential Address: Discount Rates

JOHN H. COCHRANE∗

ABSTRACT

Discount-rate variation is the central organizing question of current asset-pricing research. I survey facts, theories, and applications. Previously, we thought returns were

unpredictable, with variation in price-dividend ratios due to variation in expected

cashflows. Now it seems all price-dividend variation corresponds to discount-rate

variation. We also thought that the cross-section of expected returns came from the

CAPM. Now we have a zoo of new factors. I categorize discount-rate theories based

on central ingredients and data sources. Incorporating discount-rate variation affects

finance applications, including portfolio theory, accounting, cost of capital, capital

structure, compensation, and macroeconomics.

ASSET PRICES SHOULD EQUAL expected discounted cashflows. Forty years ago,

Eugene Fama (1970) argued that the expected part, “testing market efficiency,”

provided the framework for organizing asset-pricing research in that era. I

argue that the “discounted” part better organizes our research today.

I start with facts: how discount rates vary over time and across assets. I turn

to theory: why discount rates vary. I attempt a categorization based on central

assumptions and links to data, analogous to Fama’s “weak,” “semi-strong,” and

“strong” forms of efficiency. Finally, I point to some applications, which I think

will be strongly influenced by our new understanding of discount rates. In each

case, I have more questions than answers. This paper is more an agenda than

a summary.

I. Time-Series Facts

A. Simple Dividend Yield Regression

Discount rates vary over time. (“Discount rate,” “risk premium,” and “expected return” are all the same thing here.) Start with a very simple regression

of returns on dividend yields,1...