Maximum Entropy Analysis of Consumption-based Capital Asset Pricing Model and Volatility

Author:

Lee Tae-Hwy1,Mao Millie Yi2,Ullah Aman1

Affiliation:

1. Department of Economics , University of California , Riverside , CA , 92521 , USA

2. Department of Mathematics, Physics and Statistics , Azusa Pacific University , Azusa , CA , 91702 , USA

Abstract

Abstract Based on the maximum entropy (ME) method, we introduce an information theoretic approach to estimating conditional moment functions with incorporating a theoretical constraint implied from the consumption-based capital asset pricing model (CCAPM). Using the ME conditional mean/variance functions obtained from the ME density, we analyze the relationship between asset returns and consumption growth under the theoretical constraint of the CCAPM. We evaluate the predictability of asset return using consumption growth through in-sample estimation and out-of-sample prediction in the ME mean regression function. We also examine the ME variance regression function for the asset return volatility as a function of the consumption growth. Our findings suggest that incorporating the CCAPM constraint can capture the nonlinear predictability of asset returns in mean especially in tails, and that the consumption growth has an effect on reducing stock return volatility, indicating the counter-cyclical variation of stock market volatility.

Publisher

Walter de Gruyter GmbH

Subject

Applied Mathematics,Economics and Econometrics,Statistics and Probability

Cited by 2 articles. 订阅此论文施引文献 订阅此论文施引文献,注册后可以免费订阅5篇论文的施引文献,订阅后可以查看论文全部施引文献

1. Do Consumption-Based Asset Pricing Models Explain the Dynamics of Stock Market Returns?;Journal of Risk and Financial Management;2024-02-11

2. Abductive Inference and C. S. Peirce: 150 Years Later;Journal of Quantitative Economics;2022-12-30

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