IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Sources of Entropy in Representative Agent Models

  • David Backus
  • Mikhail Chernov
  • Stanley Zin

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.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://web-docs.stern.nyu.edu/old_web/economics/docs/workingpapers/2011/Backus11Jul2011.pdf
Download Restriction: no

Paper provided by New York University, Leonard N. Stern School of Business, Department of Economics in its series Working Papers with number 11-21.

as
in new window

Length:
Date of creation: 2011
Date of revision:
Handle: RePEc:ste:nystbu:11-21
Contact details of provider: Postal: New York University, Leonard N. Stern School of Business, Department of Economics, 44 West 4th Street, New York, NY 10012-1126
Phone: (212) 998-0860
Fax: (212) 995-4218
Web page: http://w4.stern.nyu.edu/economics/

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Lars Peter Hansen & John C. Heaton & Nan Li, 2008. "Consumption Strikes Back? Measuring Long-Run Risk," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 260-302, 04.
  2. Backus, David & Chernov, Mikhail & Martin, Ian, 2009. "Disasters implied by equity index options," CEPR Discussion Papers 7416, C.E.P.R. Discussion Papers.
  3. Benzoni, Luca & Collin-Dufresne, Pierre & Goldstein, Robert S., 2011. "Explaining asset pricing puzzles associated with the 1987 market crash," Journal of Financial Economics, Elsevier, vol. 101(3), pages 552-573, September.
  4. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
  5. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  6. René Garcia & Richard Luger & Eric Renault, 2000. "Empirical Assessment of an Intertemporal Option Pricing Model with Latent Variables," Working Papers 2000-56, Centre de Recherche en Economie et Statistique.
  7. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of Security Market Data for Models of Dynamic Economies," NBER Technical Working Papers 0089, National Bureau of Economic Research, Inc.
  8. Koijen, Ralph & Lustig, Hanno & van Nieuwerburgh, Stijn, 2012. "The Cross-Section and Time-Series of Stock and Bond Returns," CEPR Discussion Papers 9024, C.E.P.R. Discussion Papers.
  9. Bansal, Ravi & Lehmann, Bruce N., 1997. "Growth-Optimal Portfolio Restrictions On Asset Pricing Models," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 333-354, June.
  10. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  11. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
  12. Martin Lettau & Harald Uhlig, 2000. "Can Habit Formation be Reconciled with Business Cycle Facts?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(1), pages 79-99, January.
  13. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
  14. Michael F. Gallmeyer & Burton Hollifield & Francisco J. Palomino & Stanley E. Zin, 2007. "Arbitrage-free bond pricing with dynamic macroeconomic models," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 305-326.
  15. Wachter, Jessica A., 2006. "A consumption-based model of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 79(2), pages 365-399, February.
  16. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
  17. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  18. Hansen, Lars Peter & Sargent, Thomas J., 1980. "Formulating and estimating dynamic linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 7-46, May.
  19. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  20. Jose Ursua & Jon Steinsson & Emi Nakamura & Robert Barro, 2008. "Crises and Recoveries in an Empirical Model of Consumption Disasters," 2008 Meeting Papers 1089, Society for Economic Dynamics.
  21. Hansen, Lars Peter & Scheinkman, José A., 2008. "Long Term Risk : An Operator Approach," Economics Papers from University Paris Dauphine 123456789/2282, Paris Dauphine University.
  22. Bjørn Eraker & Ivan Shaliastovich, 2008. "An Equilibrium Guide To Designing Affine Pricing Models," Mathematical Finance, Wiley Blackwell, vol. 18(4), pages 519-543.
  23. Adrien Verdelhan, 2006. "A Habit-Based Explanation of the Exchange Rate Risk Premium," 2006 Meeting Papers 872, Society for Economic Dynamics.
  24. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, vol. 63(3), pages 681-717, May.
  25. David Backus & Silverio Foresi & Abon Mozumdar & Liuren Wu, 1998. "Predictable Changes in Yields and Forward Rates," NBER Working Papers 6379, National Bureau of Economic Research, Inc.
  26. Beeler, Jason & Campbell, John Y., 2012. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," Critical Finance Review, now publishers, vol. 1(1), pages 141-182, January.
  27. Ravi Bansal & Dana Kiku & Amir Yaron, 2009. "An Empirical Evaluation of the Long-Run Risks Model for Asset Prices," NBER Working Papers 15504, National Bureau of Economic Research, Inc.
  28. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
  29. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  30. Fernando Alvarez & Urban J. Jermann, 2005. "Using Asset Prices to Measure the Persistence of the Marginal Utility of Wealth," Econometrica, Econometric Society, vol. 73(6), pages 1977-2016, November.
  31. David K. Backus & Stanley E. Zin, 1994. "Reverse Engineering the Yield Curve," Working Papers 94-09, New York University, Leonard N. Stern School of Business, Department of Economics.
  32. Chernov, Mikhail & Mueller, Philippe, 2008. "The Term Structure of Inflation Expectations," CEPR Discussion Papers 6809, C.E.P.R. Discussion Papers.
  33. Jessica Wachter, 2008. "Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility?," NBER Working Papers 14386, National Bureau of Economic Research, Inc.
  34. Jules van Binsbergen & Michael Brandt & Ralph Koijen, 2012. "On the Timing and Pricing of Dividends," American Economic Review, American Economic Association, vol. 102(4), pages 1596-1618, June.
  35. Geert Bekaert & Eric Engstrom, 2009. "Asset Return Dynamics under Bad Environment Good Environment Fundamentals," NBER Working Papers 15222, National Bureau of Economic Research, Inc.
  36. Francis Longstaff & Monika Piazzesi, 2003. "Corporate Earnings and the Equity Premium," NBER Working Papers 10054, National Bureau of Economic Research, Inc.
  37. Mark Broadie & Mikhail Chernov & Michael Johannes, 2009. "Understanding Index Option Returns," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4493-4529, November.
  38. Barro, Robert, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," Scholarly Articles 3208215, Harvard University Department of Economics.
  39. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  40. Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
  41. Heaton, John, 1993. "The Interaction between Time-Nonseparable Preferences and Time Aggregation," Econometrica, Econometric Society, vol. 61(2), pages 353-85, March.
  42. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
  43. Stanley E. Zin & Bryan R. Routledge & David K. Backus, 2009. "The Cyclical Component of US Asset Returns," 2009 Meeting Papers 13, Society for Economic Dynamics.
  44. Lars Peter Hansen, 2008. "Modeling the Long Run: Valuation in Dynamic Stochastic Economies," NBER Working Papers 14243, National Bureau of Economic Research, Inc.
  45. Greg Duffee, 2010. "Sharpe ratios in term structure models," Economics Working Paper Archive 575, The Johns Hopkins University,Department of Economics.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:ste:nystbu:11-21. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Viveca Licata)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.