The Review of Asset Pricing Studies Vol. 13 No. 4 2023

Never a Dull Moment: Entropy Risk in Commodity Markets

Fousseni Chabi-Yo¹; Hitesh Doshi²; Virgilio Zurita³

¹ Isenberg School of Management, University of Massachusetts , USA · ² C. T. Bauer College of Business, University of Houston , USA · ³ Hankamer School of Business, Baylor University , USA

Abstract

We develop a new approach to determine investors’ risk compensations for all distributional moments of a security. Using the concept of entropy, which is a summary of all moments of a risky security, we derive the relationship between expected returns and their compensation for entropy risk. Entropy risk premium (ERP), which is entropy under the physical minus the risk-neutral measure, indicates the hedging cost against changes in risks associated with all moments of the return’s distribution. Applying our model to the commodity markets, we find that ERP carries economically significant information for the cross-section of returns that is different from individual or combined moments.

DOI

10.1093/rapstu/raad008

Volume

13

Issue

4

Pages

734-783

Language

en

Sources

crossref bibtex:phds-export.bib openalex

Cite

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