The Term Structures of Coentropy in International Financial Markets

Fousseni Chabi-Yo () and Riccardo Colacito ()
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Fousseni Chabi-Yo: Isenberg School of Management, University of Massachusetts Amherst, Amherst, Massachusetts 01003
Riccardo Colacito: Kenan-Flagler Business School and Department of Economics, University of North Carolina at Chapel Hill, Chapel Hill, North Carolina 27599

Management Science, 2019, vol. 65, issue 8, 3541-3558

Abstract: We propose a new entropy-based correlation measure (coentropy) to evaluate the performance of international asset pricing models. Coentropy captures the codependence of two random variables beyond normality. We document that the coentropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We employ the cross section of G-10 countries to obtain model-free estimates of all the components of coentropy at various horizons and we show that the generalization of the long-run risk model featuring two predictable components of consumption growth rates, global disasters, and recursive preferences can account for the composition of codependence at all horizons.

Keywords: finance; asset pricing; international finance; statistics; correlation (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (3)

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