Contagion and Return Predictability in Asset Markets: An Experiment With Two Lucas Trees

55 Pages Posted: 6 Sep 2019 Last revised: 20 Nov 2019

See all articles by Charles Noussair

Charles Noussair

University of Arizona

Andreea Victoria Popescu

Tilburg University - School of Economics and Management

Date Written: March 1, 2019

Abstract

Using a laboratory experiment, we investigate whether contagion can emerge between two risky assets despite an absence of correlation in their fundamentals. To guide our experimental design, we use the ‘Two trees’ asset pricing model developed by Cochrane, Longstaff and Santa-Clara (2007). We draw on the model to make predictions regarding changes in the time-series and cross-section of returns in response to fundamental value shocks. We observe positive autocorrelation in the shocked asset, and a positive contemporaneous correlation between assets, as the model predicts. The dividend-price ratio forecasts the returns of risky assets, both in the time series and in the cross-section. There is more support for the model’s predictions in markets in which traders have greater cognitive ability.

Keywords: Contagion, Asset Pricing, Two Trees Model, Experimental Finance, Time Series Momentum, Return Predictability

JEL Classification: C53, C92, D50, G12

Suggested Citation

Noussair, Charles and Popescu, Andreea Victoria, Contagion and Return Predictability in Asset Markets: An Experiment With Two Lucas Trees (March 1, 2019). Available at SSRN: https://ssrn.com/abstract=3445324 or http://dx.doi.org/10.2139/ssrn.3445324

Charles Noussair

University of Arizona ( email )

McClelland Hall
Tucson, AZ 85721-0108
United States

Andreea Victoria Popescu (Contact Author)

Tilburg University - School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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