An Experimental Test of the Lucas Asset Pricing Model

Sean Crockett, John Duffy and Yehuda Izhakian

Abstract

We implement a dynamic asset pricing experiment in the spirit of Lucas (1978) with storable assets and non-storable cash. In the first treatment, we impose diminishing marginal returns to cash to incentivize consumption-smoothing across periods. We find that subjects use the asset to smooth consumption, although the asset trades at a discount relative to the risk-neutral fundamental price. This under-pricing is a departure from the asset price \bubbles" observed in the large experimental asset pricing literature originating with Smith et al. (1988) and can be rationalized by considering subjects' risk aversion with respect to uncertain money earnings. In a second treatment, with no induced motivation for trade a la the Smith et al. design, we nd that the asset trades at a premium relative to its expected value and that shareholdings are highly concentrated. Elimination of asset price uncertainty in additional experimental treatments serves to reinforce the same observations, and suggests that speculative considerations may explain departures from expected value in environments without a consumption smoothing motive for asset trades.