Two Trees

Posted: 26 Jun 2008

See all articles by John H. Cochrane

John H. Cochrane

Hoover Institution; National Bureau of Economic Research (NBER); University of Chicago - Booth School of Business

Francis A. Longstaff

University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: January 2008

Abstract

We solve a model with two i.i.d. Lucas trees. Although the corresponding one-tree model produces a constant price-dividend ratio and i.i.d. returns, the two-tree model produces interesting asset-pricing dynamics. Investors want to rebalance their portfolios after any change in value. Because the size of the trees is fixed, prices must adjust to offset this desire. As a result, expected returns, excess returns, and return volatility all vary through time. Returns display serial correlation and are predictable from price-dividend ratios. Return volatility differs from cash-flow volatility, and return shocks can occur without news about cash flows.

Suggested Citation

Cochrane, John H. and Longstaff, Francis A. and Santa-Clara, Pedro, Two Trees (January 2008). The Review of Financial Studies, Vol. 21, Issue 1, pp. 347-385, 2008. Available at SSRN: https://ssrn.com/abstract=1151585 or http://dx.doi.org/hhm059

John H. Cochrane (Contact Author)

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National Bureau of Economic Research (NBER)

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Francis A. Longstaff

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2218 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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