The Lucas Orchard
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.
I thank Tobias Adrian, Malcolm Baker, Thomas Baranga, Robert Barro, John Cochrane, George Constantinides, Josh Coval, Emmanuel Farhi, Xavier Gabaix, Lars Hansen, Jakub Jurek, David Laibson, Robert Lucas, Greg Mankiw, Emi Nakamura, Martin Oehmke, Lubos Pastor, Monika Piazzesi, Roberto Rigobon, David Skeie, Jon Steinsson, Aleh Tsyvinski, Harald Uhlig, Pietro Veronesi, Luis Viceira, James Vickery, and Jiang Wang for their comments. I am particularly grateful to John Campbell and Chris Rogers for their advice. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Ian Martin, 2013. "The Lucas Orchard," Econometrica, Econometric Society, vol. 81(1), pages 55-111, 01. citation courtesy of