Diagnosing Dynamic Asset Pricing Models with Generalized Entropy Bounds
26 Pages Posted: 22 Nov 2013 Last revised: 23 Jan 2018
Date Written: January 22, 2018
I examine moment characteristics and predictability assumptions of dynamic asset pricing models. I propose a new measure --- the generalized entropy --- to summarize moment information of the multi-horizon pricing kernel for a dynamic model. Both static and dynamic strategy returns impose robust restrictions on the generalize entropy, providing a way to test candidate models. Applying this test to leading representative agent models and by creating dynamic strategies that depend on model-implied predictive signals, I find that models featuring growth uncertainty is able to explain market data better.
Keywords: higher order moments, pricing kernel, entropy, conditioning information, horizon dependence, model diagnosis
JEL Classification: C14, G10, G11, G12
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