  The valuation process that economic agents undergo for investments with
uncertain payoff typically depends on their statistical views on possible
future outcomes, their attitudes toward risk, and, of course, the payoff
structure itself. Yields vary across different investment opportunities and
their interrelations are difficult to explain. For the same agent, a different
discounting factor has to be used for every separate valuation occasion. If,
however, one is ready to accept discounting that varies randomly with the
possible outcomes, and therefore accepts the concept of a stochastic discount
factor, then an economically consistent theory can be developed. Asset
valuation becomes a matter of randomly discounting payoffs under different
states of nature and weighing them according to the agent's probability
structure. The advantages of this approach are obvious, since a single
discounting mechanism suffices to describe how any asset is priced by the
agent.
