Econometrica: Jan 2013, Volume 81, Issue 1

The Lucas Orchard

https://doi.org/10.3982/ECTA8446
p. 55-111

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 cashflows. Very small assets may comove endogenously and hence earn positive risk premia even if their cashflows 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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Supplemental Material

Supplement to "The Lucas Orchard"

This PDF contains the online appendix.

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Supplement to "The Lucas Orchard"

This zip file contains Mathematica notebooks that calculate the integral formulas in the two-, three-, and N-tree cases.

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