The Lucas Orchard


  • Ian Martin

    1. Stanford Graduate School of Business, Stanford University, Stanford, CA 94305, U.S.A.;
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    • 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 Pástor, Roberto Rigobon, David Skeie, Jon Steinsson, Aleh Tsyvinski, 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; and to the editor and four anonymous referees for their detailed comments.


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.