Sources of Entropy in Representative Agent Models

@inproceedings{Backus2011SourcesOE,
  title={Sources of Entropy in Representative Agent Models},
  author={David K. Backus and Mikhail Chernov},
  year={2011}
}
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… CONTINUE READING
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