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Pá 16.03.2012

Prof. Stanley Zin: “Sources of entropy in representative agent models”

Prof. Stanley Zin

New York University Stern School of Business, USA

Authors: David Backus, Mikhail Chernov, and Stanley Zin

Abstract: 

We propose two performance measures for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The measures describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (horizon dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and horizon dependence, and compare their magnitudes to estimates derived from asset returns. This exercise — and transparent loglinear approximations — clarify 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 horizon dependence, which should be small enough to account for mean yield spreads.

JEL Classification Codes: E44, G12.

Keywords: pricing kernel, asset returns, bond yields, recursive preferences, habits, jumps, disasters.

Full Text: “Sources of entropy in representative agent models”