Productivity-based asset pricing: Theory and evidence

In a general real business cycle model, we derive a pricing kernel that involves only production function arguments. The productivity shock is the single factor and the capital stock relative to a productivity measure is the conditioning variable. The model compares favorably with the complementary consumption-based and market-based approaches and with the Fama-French three-factor model. A size premium arises from differences in unconditional sensitivities—small firms are more sensitive to productivity shocks—and a value premium from differences in conditional sensitivities to productivity shocks—growth firms are more sensitive to productivity shocks when the productivity risk premium is low.