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

Author

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  • Bakshi, Gurdip

    (University of MD)

  • Chabi-Yo, Fousseni

    (OH State University)

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.

Suggested Citation

  • Bakshi, Gurdip & Chabi-Yo, Fousseni, 2014. "New Entropy Restrictions and the Quest for Better Specified Asset Pricing Models," Working Paper Series 2014-07, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2014-07
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    Cited by:

    1. Nikolay Gospodinov & Esfandiar Maasoumi, 2017. "General Aggregation of Misspecified Asset Pricing Models," FRB Atlanta Working Paper 2017-10, Federal Reserve Bank of Atlanta.
    2. Gospodinov, Nikolay & Maasoumi, Esfandiar, 2021. "Generalized aggregation of misspecified models: With an application to asset pricing," Journal of Econometrics, Elsevier, vol. 222(1), pages 451-467.

    More about this item

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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