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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://www.nber.org/papers/w17563.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17563.

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Date of creation: Nov 2011
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Publication status: published as Ian Martin, 2013. "The Lucas Orchard," Econometrica, Econometric Society, vol. 81(1), pages 55-111, 01.
Handle: RePEc:nbr:nberwo:17563
Note: AP EFG IFM
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  1. Ian Martin, 2010. "Consumption-Based Asset Pricing with Higher Cumulants," NBER Working Papers 16153, National Bureau of Economic Research, Inc.
  2. Anna Pavlova & Roberto Rigobon, 2003. "Asset Prices and Exchange Rates," NBER Working Papers 9834, National Bureau of Economic Research, Inc.
  3. Lubos Pastor & Pietro Veronesi, 2002. "Stock Valuation and Learning about Profitability," NBER Working Papers 8991, National Bureau of Economic Research, Inc.
  4. Pástor, Luboš & Veronesi, Pietro, 2004. "Was There A Nasdaq Bubble in the Late 1990s?," CEPR Discussion Papers 4485, C.E.P.R. Discussion Papers.
  5. Ian Martin, 2010. "The Valuation of Long-Dated Assets," NBER Working Papers 16219, National Bureau of Economic Research, Inc.
  6. Campbell, John Y. & Mei, Jianping, 1993. "Where Do Betas Come From? Asset Price Dynamics and the Sources of Systematic Risk," Scholarly Articles 3353757, Harvard University Department of Economics.
  7. 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.
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