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Sources of Entropy in Representative Agent Models

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  • David Backus
  • Mikhail Chernov
  • Stanley E. Zin

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17219.

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Date of creation: Jul 2011
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Publication status: published as \Sources of entropy in representative agent models," with M. Chernov and S. Zin, 2014, Journal of Finance 69, 51-99.
Handle: RePEc:nbr:nberwo:17219

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Cited by:
  1. Anisha Ghosh & Christian Julliard, 2011. "What is the Consumption-CAPM missing? An informative-Theoretic Framework for the Analysis of Asset Pricing Models," FMG Discussion Papers, Financial Markets Group dp691, Financial Markets Group.
  2. Jaroslav Borovička & Lars P. Hansen & José A. Scheinkman, 2014. "Misspecified Recovery," NBER Working Papers 20209, National Bureau of Economic Research, Inc.
  3. Lars Peter Hansen, 2014. "Uncertainty Outside and Inside Economic Models," Working Papers, Becker Friedman Institute for Research In Economics 2014-06, Becker Friedman Institute for Research In Economics.
  4. Lars Peter Hansen, 2014. "Uncertainty Outside and Inside Economic Models," NBER Working Papers 20394, National Bureau of Economic Research, Inc.
  5. Jaroslav Borovicka & Lars Hansen, 2012. "Examining macroeconomic models through the lens of asset pricing," Working Paper Series, Federal Reserve Bank of Chicago WP-2012-01, Federal Reserve Bank of Chicago.

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