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Relative Entropy and Minimum-Variance Pricing Kernel in Asset Pricing Model Evaluation.

ABSTRACT: Recent literature shows that many testing procedures used to evaluate asset pricing models result in spurious rejection probabilities. Model misspecification, the strong factor structure of test assets, or skewed test statistics largely explain this. In this paper we use the relative entropy of pricing kernels to provide an alternative framework for testing asset pricing models. Building on the fact that the law of one price guarantees the existence of a valid pricing kernel, we study the relationship between the mean-variance efficiency of a model's factor-mimicking portfolio, as measured by the cross-sectional generalized least squares (GLS) R 2 statistic, and the relative entropy of the pricing kernel, as determined by the Kullback-Leibler divergence. In this regard, we suggest an entropy-based decomposition that accurately captures the divergence between the factor-mimicking portfolio and the minimum-variance pricing kernel resulting from the Hansen-Jagannathan bound. Our results show that, although GLS R 2 statistics and relative entropy are strongly correlated, the relative entropy approach allows us to explicitly decompose the explanatory power of the model into two components, namely, the relative entropy of the pricing kernel and that corresponding to its correlation with asset returns. This makes the relative entropy a versatile tool for designing robust tests in asset pricing.

SUBMITTER: Rojo-Suarez J

PROVIDER: S-EPMC7517259 | biostudies-literature | 2020 Jun

REPOSITORIES: biostudies-literature

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Relative Entropy and Minimum-Variance Pricing Kernel in Asset Pricing Model Evaluation.

Rojo-Suárez Javier J Alonso-Conde Ana Belén AB

Entropy (Basel, Switzerland) 20200630 7

Recent literature shows that many testing procedures used to evaluate asset pricing models result in spurious rejection probabilities. Model misspecification, the strong factor structure of test assets, or skewed test statistics largely explain this. In this paper we use the relative entropy of pricing kernels to provide an alternative framework for testing asset pricing models. Building on the fact that the law of one price guarantees the existence of a valid pricing kernel, we study the relati ...[more]

PMID: 33286493

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Project description:ObjectiveTo determine the impact of minimum unit pricing (MUP) on the primary outcome of alcohol-related hospitalisation, and secondary outcomes of length of stay, hospital mortality and alcohol-related liver disease in hospital.DesignDatabases MEDLINE, Embase, Scopus, APA Psycinfo, CINAHL Plus and Cochrane Reviews were searched from 1 January 2011 to 11 November 2022. Inclusion criteria were studies evaluating the impact of minimum pricing policies, and we excluded non-minimum pricing policies or studies without alcohol-related hospital outcomes. The Effective Public Health Practice Project tool was used to assess risk of bias, and the Bradford Hill Criteria were used to infer causality for outcome measures.SettingMUP sets a legally required floor price per unit of alcohol and is estimated to reduce alcohol-attributable healthcare burden.ParticipantAll studies meeting inclusion criteria from any country INTERVENTION: Minimum pricing policy of alcohol PRIMARY AND SECONDARY OUTCOME MEASURES: RESULTS: 22 studies met inclusion criteria; 6 natural experiments and 16 modelling studies. Countries included Australia, Canada, England, Northern Ireland, Ireland, Scotland, South Africa and Wales. Modelling studies estimated that MUP could reduce alcohol-related admissions by 3%-10% annually and the majority of real-world studies demonstrated that acute alcohol-related admissions responded immediately and reduced by 2%-9%, and chronic alcohol-related admissions lagged by 2-3 years and reduced by 4%-9% annually. Minimum pricing could target the heaviest consumers from the most deprived groups who tend to be at greatest risk of alcohol harms, and in so doing has the potential to reduce health inequalities. Using the Bradford Hill Criteria, we inferred a 'moderate-to-strong' causal link that MUP could reduce alcohol-related hospitalisation.ConclusionsNatural studies were consistent with minimum pricing modelling studies and showed that this policy could reduce alcohol-related hospitalisation and health inequalities.Prospero registration numberCRD42021274023.

Dataset Information

Relative Entropy and Minimum-Variance Pricing Kernel in Asset Pricing Model Evaluation.

Publications

Relative Entropy and Minimum-Variance Pricing Kernel in Asset Pricing Model Evaluation.

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