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

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  • Noussair, Charles N.
  • Popescu, Andreea Victoria
Abstract
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.

Suggested Citation

  • Noussair, Charles N. & Popescu, Andreea Victoria, 2021. "Comovement and return predictability in asset markets: An experiment with two Lucas trees," Journal of Economic Behavior & Organization, Elsevier, vol. 185(C), pages 671-687.
    • Handle: RePEc:eee:jeborg:v:185:y:2021:i:c:p:671-687
    DOI: 10.1016/j.jebo.2021.03.012
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    Cited by:

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    2. Lucy F. Ackert & Brian D. Kluger & Li Qi & Lijia Wei, 2022. "An experimental examination of the flow of irrelevant information across markets," Southern Economic Journal, John Wiley & Sons, vol. 88(3), pages 1119-1148, January.
    3. Halim, Edward & Riyanto, Yohanes E. & Roy, Nilanjan, 2022. "Sharing idiosyncratic risk even though prices are “wrong”," Journal of Economic Theory, Elsevier, vol. 200(C).

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    More about this item

    Keywords

    Comovement; Asset pricing; Two trees model; Experimental finance; Time series momentum; Return predictability;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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