Working Paper: NBER ID: w17563
Authors: 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.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| disaster occurrence (H84) | price decline of Asset 1 (G19) |
| disaster occurrence (H84) | risk premium of Asset 1 (G19) |
| news about Asset 2 (Y70) | valuation ratio of Asset 1 (G32) |
| risk aversion increase (D81) | risk premium of Asset 1 (G19) |
| risk premium of Asset 1 (G19) | price-dividend ratio of Asset 1 (G19) |