Comovement and return predictability in asset markets: An experiment with two Lucas trees

Using a laboratory experiment, we investigate whether comovement can emerge between two risky assets, despite their fundamentals not being correlated. The ‘Two trees’ asset pricing model developed by Cochrane et al. (2007) guides our experimental design and its predictions serve as our source of hypotheses. The model makes time-series and cross-section return predictions following a shock to one of the two assets’ dividend distributions. As the model predicts, we observe (1) positive contemporaneous correlation between the two assets, (2) positive autocorrelation in the shocked asset, and (3) time-series and cross-sectional return predictability from the dividend-price ratio. In line with the rational foundations of the model, the model's predictions have stronger support in markets with relatively sophisticated agents. © 2021 Elsevier B.V.36 month embargo; available online 7 April 2021This item from the UA Faculty Publications collection is made available by the University of Arizona with support from the University of Arizona Libraries. If you have questions, please contact us at repository@u.library.arizona.edu