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Comparing Entropy and Beta as Measures of Risk in Asset Pricing

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  • Galina Deeva

    (Department of Finance, Faculty of Economics and Administration, Masaryk University, Lipová 41a, 602 00 Brno, Czech Republic)

Abstract

The paper establishes entropy as a measure of risk in asset pricing models by comparing its explanatory power with that of classic capital asset pricing model's beta to describe the diversity in expected risk premiums. Three different non-parametric estimation procedures are considered to evaluate financial entropy, namely kernel density estimated Shannon entropy, kernel density estimated Rényi entropy and maximum likelihood Miller-Madow estimated Shannon entropy. The comparison is provided based on the European stock market data, for which the basic risk-return trade-off is generally negative. Kernel density estimated Shannon entropy provides the most efficient results not dependent on the choice of the market benchmark and without imposing any prior model restrictions.

Suggested Citation

  • Galina Deeva, 2017. "Comparing Entropy and Beta as Measures of Risk in Asset Pricing," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 65(6), pages 1889-1894.
    • Handle: RePEc:mup:actaun:actaun_2017065061889
    DOI: 10.11118/actaun201765061889
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    References listed on IDEAS

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    1. Maasoumi, Esfandiar & Racine, Jeff, 2002. "Entropy and predictability of stock market returns," Journal of Econometrics, Elsevier, vol. 107(1-2), pages 291-312, March.
    2. Jiuping Xu & Xiaoyang Zhou & Desheng Wu, 2011. "Portfolio selection using λ mean and hybrid entropy," Annals of Operations Research, Springer, vol. 185(1), pages 213-229, May.
    3. Aslanidis, Nektarios & Christiansen, Charlotte & Savva, Christos S., 2016. "Risk-return trade-off for European stock markets," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 84-103.
    4. Mihaly Ormos & David Zibriczky, 2015. "Entropy-Based Financial Asset Pricing," Papers 1501.01155, arXiv.org.
    5. Mihály Ormos & Dávid Zibriczky, 2014. "Entropy-Based Financial Asset Pricing," PLOS ONE, Public Library of Science, vol. 9(12), pages 1-21, December.
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    Cited by:

    1. Noe Rodriguez-Rodriguez & Octavio Miramontes, 2022. "Shannon entropy: an econophysical approach to cryptocurrency portfolios," Papers 2210.02633, arXiv.org.

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