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

CentER Discussion Paper Series Nr. 2020-014

54 Pages Posted: 19 May 2020

See all articles by Charles Noussair

Charles Noussair

University of Arizona

Andreea Victoria Popescu

Tilburg University - Center for Economic Research (CentER)

Date Written: April 21, 2020

Abstract

Using a laboratory experiment, we investigate whether contagion can emerge between two risky assets, even when their fundamentals are not correlated. To guide our experimental design, we use the ‘Two trees’ asset pricing model developed by Cochrane et al. (2007). 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 auto correlations in the shocked asset, (2) a positive contemporaneous correlation between the two assets, and (3) time-series and cross-sectional return predictability from the dividend price ratio. In line with the rational foundation of the model, the model’s predictions have stronger support in markets with relatively sophisticated agents.

Keywords: contagion; asset pricing; two trees model; experimental pricing; 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 (April 21, 2020). CentER Discussion Paper Series Nr. 2020-014, Available at SSRN: https://ssrn.com/abstract=3581575

Charles Noussair (Contact Author)

University of Arizona ( email )

McClelland Hall
Tucson, AZ 85721-0108
United States

Andreea Victoria Popescu

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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