Sources of entropy in representative agent models

David Backus, Stanley Zin and Mikhail Chernov

No 8488, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We propose two metrics for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The metrics describe the pricing kernel?s dispersion (the entropy of the title) and dynamics (time dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and time dependence and compare their magnitudes to estimates derived from asset returns. This exercise--and transparent loglinear approximations--clarifies the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and time dependence, which should be small enough to account for mean yield spreads.

Keywords: Pricing kernel; Asset returns; Bond yields; Disasters; Habits; Jumps; Recursive preferences (search for similar items in EconPapers)
JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 2011-07
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Related works:
Journal Article: Sources of Entropy in Representative Agent Models (2014)
Working Paper: Sources of Entropy in Representative Agent Models (2011)
Working Paper: Sources of Entropy in Representative Agent Models (2011)
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