The Cross-Section of Expected Stock Returns: Learning about Distress and Predictability in Heterogeneous Orchards

84 Pages Posted: 22 Mar 2010 Last revised: 26 Oct 2010

See all articles by Andrea Buraschi

Andrea Buraschi

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Paolo Porchia

IE Business School

Fabio Trojani

Swiss Finance Institute; University of Geneva

Date Written: October 16, 2010


We study an equilibrium asset pricing model with several Lucas (1978) trees subject to persistent distress events, where the agent has incomplete information about the state of an underlying common factor and learns from the events occurring to each tree. Contrary to similar asset pricing models with learning in one-tree economies, we find that cross-sectional learning and distress events can reverse several implications and help to explain empirical equity premia and risk-free rate dynamics. We also find that learning helps to generate more realistic dispersion of cross-sectional expected returns, relative to pure aggregate consumption risk models with complete information and disaster risk. The model provides a simple setting to study the asset pricing implications of orchards in which the cash flow links among different trees are asymmetric and some trees are more exogeneous than others. This allows, among other things, to link reduced-form assumptions of cash-flow risk heterogeneity to the structural properties of the orchard. Finally, we show that the cash-flow connectivity of a firm in the orchard is linked to the slope of the dividend strip curve. Sectors whose dividend process is exogenous in the orchard have negatively sloped term structures of dividend swaps. The opposite holds for endogenous sectors.

Keywords: General Equilibrium, Event Risk, Learning

JEL Classification: G12, G13, D50

Suggested Citation

Buraschi, Andrea and Porchia, Paolo and Trojani, Fabio, The Cross-Section of Expected Stock Returns: Learning about Distress and Predictability in Heterogeneous Orchards (October 16, 2010). AFA 2011 Denver Meetings Paper, Available at SSRN: or

Andrea Buraschi

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom


Centre for Economic Policy Research (CEPR)

United Kingdom

Paolo Porchia (Contact Author)

IE Business School ( email )

Serrano 99
Madrid, 28006
+34917821706 (Phone)
+34 91 745 47 62 (Fax)


Fabio Trojani

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

University of Geneva ( email )

Geneva, Geneva

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