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An Experimental Test of the Lucas Asset Pricing Model

Author

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  • Sean Crockett
  • John Duffy
  • Yehuda Izhakian

Abstract

We implement a dynamic asset pricing experiment in the spirit of Lucas (1978) with storable assets and non-storable cash. In the first treatment, we impose diminishing marginal returns to cash to incentivize consumption smoothing across periods. We find that subjects use the asset to smooth consumption, although the asset trades at a discount relative to the risk-neutral fundamental price. This under-pricing is a departure from the asset price “bubbles” observed in the large experimental asset pricing literature originating with Smith et al. (1988) and can be rationalized by considering subjects’ risk aversion with respect to uncertain money earnings. In a second treatment, with no induced motivation for trade à la the Smith et al. design, we find that the asset trades at a premium relative to its expected value and that shareholdings are highly concentrated. Elimination of asset price uncertainty in additional experimental treatments serves to reinforce the same observations, and suggests that speculative behaviour explains the departure of prices from fundamental value in the absence of a consumption-smoothing motive for asset trades.

Suggested Citation

  • Sean Crockett & John Duffy & Yehuda Izhakian, 2019. "An Experimental Test of the Lucas Asset Pricing Model," Review of Economic Studies, Oxford University Press, vol. 86(2), pages 627-667.
  • Handle: RePEc:oup:restud:v:86:y:2019:i:2:p:627-667.
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    File URL: http://hdl.handle.net/10.1093/restud/rdy035
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    Citations

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    Cited by:

    1. Hirota, Shinichi & Huber, Juergen & Stöckl, Thomas & Sunder, Shyam, 2022. "Speculation, money supply and price indeterminacy in financial markets: An experimental study," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 1275-1296.
    2. Evans, George W. & Hommes, Cars & McGough, Bruce & Salle, Isabelle, 2022. "Are long-horizon expectations (de-)stabilizing? Theory and experiments," Journal of Monetary Economics, Elsevier, vol. 132(C), pages 44-63.
    3. Penalver, Adrian & Hanaki, Nobuyuki & Akiyama, Eizo & Funaki, Yukihiko & Ishikawa, Ryuichiro, 2020. "A quantitative easing experiment," Journal of Economic Dynamics and Control, Elsevier, vol. 119(C).
    4. Tiziana Assenza & Te Bao & Cars Hommes & Domenico Massaro, 2014. "Experiments on Expectations in Macroeconomics and Finance," Research in Experimental Economics, in: John Duffy (ed.), Experiments in Macroeconomics, volume 17, pages 11-70, Emerald Publishing Ltd.
    5. Matthias Weber & John Duffy & Arthur Schram, 2018. "An Experimental Study of Bond Market Pricing," Journal of Finance, American Finance Association, vol. 73(4), pages 1857-1892, August.
    6. Te Bao & Edward Halim & Charles N. Noussair & Yohanes E. Riyanto, 2021. "Managerial incentives and stock price dynamics: an experimental approach," Experimental Economics, Springer;Economic Science Association, vol. 24(2), pages 617-648, June.
    7. Galí, Jordi & Giusti, Giovanni & Noussair, Charles N., 2021. "Monetary Policy and Asset Price Bubbles: A Laboratory Experiment," Journal of Economic Dynamics and Control, Elsevier, vol. 130(C).
    8. Bohr, Clement E. & Holt, Charles A. & Schubert, Alexandra V., 2019. "Assisted savings for retirement: An experimental analysis," European Economic Review, Elsevier, vol. 119(C), pages 42-54.
    9. Guidon Fenig & Luba Petersen, 2017. "Distributing scarce jobs and output: experimental evidence on the dynamic effects of rationing," Experimental Economics, Springer;Economic Science Association, vol. 20(3), pages 707-735, September.
    10. John Duffy & Janet Hua Jiang & Huan Xie, 2021. "Pricing Indefinitely Lived Assets: Experimental Evidence," CIRANO Working Papers 2021s-32, CIRANO.
    11. Shinichi Hirota & Juergen Huber & Thomas Stock & Shyam Sunder, 2018. "Speculation and Price Indeterminacy in Financial Markets: An Experimental Study," Cowles Foundation Discussion Papers 2134R, Cowles Foundation for Research in Economics, Yale University, revised Apr 2020.
    12. Alex Chinco & Samuel M. Hartzmark & Abigail B. Sussman, 2022. "A New Test of Risk Factor Relevance," Journal of Finance, American Finance Association, vol. 77(4), pages 2183-2238, August.
    13. Jieyi Duan & Nobuyuki Hanaki, 2021. "The impact of asset purchases in an experimental market with consumption smoothing motives," ISER Discussion Paper 1147r, Institute of Social and Economic Research, Osaka University, revised Sep 2022.
    14. Elena Asparouhova & Peter Bossaerts & Nilanjan Roy & William Zame, 2016. "“Lucas” in the Laboratory," Journal of Finance, American Finance Association, vol. 71(6), pages 2727-2780, December.
    15. Camille Cornand & Frank Heinemann, 2018. "Experiments on macroeconomics: methods and applications," Working Papers 1810, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    16. Duffy, John & Rabanal, Jean Paul & Rud, Olga, 2021. "Market Experiments with Multiple Assets: A survey," UiS Working Papers in Economics and Finance 2021/4, University of Stavanger.
    17. Airaudo, Marco, 2020. "Temptation and forward-guidance," Journal of Economic Theory, Elsevier, vol. 186(C).
    18. Jieyi Duan & Nobuyuki Hanaki, 2021. "The impact of asset purchases in an experimental market with consumption smoothing motives," ISER Discussion Paper 1147, Institute of Social and Economic Research, Osaka University.
    19. Enrica Carbone & John Hey & Tibor Neugebauer, 2018. "An Experimental Comparison of Two Exchange Mechanisms, An Asset Market versus a Credit Market," Discussion Papers 18/08, Department of Economics, University of York.
    20. Alexander M. Chinco & Samuel M. Hartzmark & Abigail B. Sussman, 2020. "Necessary Evidence For A Risk Factor’s Relevance," NBER Working Papers 27227, National Bureau of Economic Research, Inc.
    21. Giovanni Giusti & Janet Hua Jiang & Yiping Xu, 2014. "Interest on Cash, Fundamental Value Process and Bubble Formation on Experimental Asset Markets," Staff Working Papers 14-18, Bank of Canada.
    22. Halim, Edward & Riyanto, Yohanes E. & Roy, Nilanjan, 2022. "Sharing idiosyncratic risk even though prices are “wrong”," Journal of Economic Theory, Elsevier, vol. 200(C).
    23. Sean Crockett & Daniel Friedman & Ryan Oprea, 2021. "Naturally Occurring Preferences And General Equilibrium: A Laboratory Study," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 62(2), pages 831-859, May.
    24. Noussair, Charles N. & Popescu, Andreea Victoria, 2021. "Comovement and return predictability in asset markets: An experiment with two Lucas trees," Journal of Economic Behavior & Organization, Elsevier, vol. 185(C), pages 671-687.

    More about this item

    Keywords

    Asset pricing; Lucas Tree Model; Experimental economics; General equilibrium; Intertemporal choice; Macrofinance; Consumption smoothing;
    All these keywords.

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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