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The Lucas Orchard

  • Ian Martin

This paper investigates the behavior of asset prices in an endowment economy in which a representative agent with power utility consumes the dividends of multiple assets. The assets are Lucas trees; a collection of Lucas trees is a Lucas orchard. The model generates return correlations that vary endogenously, spiking at times of disaster. Since disasters spread across assets, the model generates large risk premia even for assets with stable fundamentals. Very small assets may comove endogenously and hence earn positive risk premia even if their fundamentals are independent of the rest of the economy. I provide conditions under which the variation in a small asset's price-dividend ratio can be attributed almost entirely to variation in its risk premium.

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File URL: http://hdl.handle.net/10.3982/ECTA8446
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Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 81 (2013)
Issue (Month): 1 (01)
Pages: 55-111

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Handle: RePEc:ecm:emetrp:v:81:y:2013:i:1:p:55-111
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  1. John Campbell & Jianping Mei, 1993. "Where do Betas Come From? Asset Price Dynamics and the Sources of Systematic Risk," NBER Working Papers 4329, National Bureau of Economic Research, Inc.
  2. Hui Chen & Scott Joslin, 2011. "Generalized Transform Analysis of Affine Processes and Applications in Finance," NBER Working Papers 16906, National Bureau of Economic Research, Inc.
  3. Ian Martin, 2012. "On the Valuation of Long-Dated Assets," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 346 - 358.
  4. Ian W. Martin, 2013. "Consumption-Based Asset Pricing with Higher Cumulants," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 745-773.
  5. Lubos Pastor & Pietro Veronesi, 2002. "Stock Valuation and Learning about Profitability," NBER Working Papers 8991, National Bureau of Economic Research, Inc.
  6. Lubos Pastor & Pietro Veronesi, 2004. "Was There a Nasdaq Bubble in the Late 1990s?," NBER Working Papers 10581, National Bureau of Economic Research, Inc.
  7. Roberto Rigobon & Anna Pavlova, 2004. "Asset Prices and Exchange Rates," Econometric Society 2004 North American Winter Meetings 579, Econometric Society.
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