| Abstract: | We solve a model with two i.i.d. Lucas trees. Although the correspondingone-tree model produces a constant price-dividend ratio andi.i.d. returns, the two-tree model produces interesting asset-pricingdynamics. Investors want to rebalance their portfolios afterany change in value. Because the size of the trees is fixed,prices must adjust to offset this desire. As a result, expectedreturns, excess returns, and return volatility all vary throughtime. Returns display serial correlation and are predictablefrom price-dividend ratios. Return volatility differs from cash-flowvolatility, and return shocks can occur without news about cashflows. |
