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The Term Structures of Coentropy in International Financial Markets

Fisher College of Business Working Paper No. 2013-03-17

Charles A. Dice Center Working Paper No. 2013-17

54 Pages Posted: 24 Oct 2013 Last revised: 22 Sep 2017

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Riccardo Colacito

University of North Carolina Kenan-Flagler Business School

Date Written: September 21, 2017

Abstract

We propose a new entropy-based correlation measure (coentropy) to evaluate the performance of international asset pricing models. Coentropy captures the codependence of two random variables beyond normality. We document that the coentropy of international stochastic discount factors (SDFs) can be decomposed into a series of entropy-based correlations of permanent and transitory components of the SDFs. We employ the cross section of G-10 countries to obtain model-free estimates of all the components of coentropy at various horizons and show that a model featuring two predictable components of consumption growth rates, global disasters, and recursive preferences is needed to account for the composition of codependence at all horizons.

JEL Classification: C62, F31, G12

Suggested Citation

Chabi-Yo, Fousseni and Colacito, Riccardo, The Term Structures of Coentropy in International Financial Markets (September 21, 2017). Fisher College of Business Working Paper No. 2013-03-17; Charles A. Dice Center Working Paper No. 2013-17. Available at SSRN: https://ssrn.com/abstract=2341772 or http://dx.doi.org/10.2139/ssrn.2341772

Fousseni Chabi-Yo (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Riccardo Colacito

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://www.unc.edu/~colacitr

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