New Entropy Restrictions and the Quest for Better Specified Asset Pricing Models

Gurdip Bakshi and Fousseni Chabi-Yo
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Gurdip Bakshi: University of MD
Fousseni Chabi-Yo: OH State University

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Under the setting that stochastic discount factors (SDFs) jointly price a vector of returns, this paper features entropy-based restrictions on SDFs, and its correlated multiplicative components, to evaluate asset pricing models. Specifically, our entropy bound on the square of the SDFs is intended to capture the time-variation in the conditional volatility of the log SDF as well as distributional non-normalities. Each entropy bound can be inferred from the mean and the variance-covariance matrix of the vector of asset returns. Extending extant treatments, we develop entropy codependence measures and our bounds generalize to multi-period SDFs. Our approach offer ways to improve model performance.

JEL-codes: C51 C52 G12 (search for similar items in EconPapers)
Date: 2014-05
New Economics Papers: this item is included in nep-ecm, nep-ger and nep-ore
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2014-07

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