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Never a Dull Moment: Entropy Risk in Commodity Markets

Author

Listed:
  • Fousseni Chabi-Yo
  • Hitesh DoshiC. T. Bauer
  • Virgilio Zurita
  • Zhiguo He

Abstract

We develop a new approach to determine investors’ risk compensations for all distributional moments of a security. Using the concept of entropy, which is a summary of all moments of a risky security, we derive the relationship between expected returns and their compensation for entropy risk. Entropy risk premium (ERP), which is entropy under the physical minus the risk-neutral measure, indicates the hedging cost against changes in risks associated with all moments of the return’s distribution. Applying our model to the commodity markets, we find that ERP carries economically significant information for the cross-section of returns that is different from individual or combined moments.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Fousseni Chabi-Yo & Hitesh DoshiC. T. Bauer & Virgilio Zurita & Zhiguo He, 2023. "Never a Dull Moment: Entropy Risk in Commodity Markets," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 13(4), pages 734-783.
    • Handle: RePEc:oup:rasset:v:13:y:2023:i:4:p:734-783.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raad008
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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