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The Lucas Orchard

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  • Ian Martin

Abstract

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.

Suggested Citation

  • Ian Martin, 2011. "The Lucas Orchard," NBER Working Papers 17563, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17563
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    References listed on IDEAS

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    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
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    5. Anna Pavlova & Roberto Rigobon, 2007. "Asset Prices and Exchange Rates," Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1139-1180.
    6. Ian W. Martin, 2013. "Consumption-Based Asset Pricing with Higher Cumulants," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 745-773.
    7. Hui Chen & Scott Joslin, 2012. "Generalized Transform Analysis of Affine Processes and Applications in Finance," Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2225-2256.
    8. Ian Martin, 2012. "On the Valuation of Long-Dated Assets," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 346-358.
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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