Experiments on the Lucas Asset Pricing Model∗

This paper reports on experimental tests of the Lucas asset pricing model with heterogeneous agents and time-varying (individual) endowment streams. In order to emulate key features of the model (infinite horizon, stationarity, perishability of consumption), a novel experimental design was required. The experimental evidence provides broad support for the cross-sectional, inter-temporal pricing and consumption smoothing/risk sharing predictions of the model – but asset prices display volatility beyond that explained by fundamentals. The paper suggests that this divergence arises from participants’ expectations about future prices, which are incorrect (at odds with the theoretical predictions of the Lucas model) but are nonetheless almost self-fulfilling.