Seeing the Unobservable from the Invisible: The Role of CO2 in Measuring Consumption Risk
Zhuo Chen, Andrea Lu
REVIEW OF FINANCE | OXFORD UNIV PRESS | Published : 2018
In contrast to past studies that assume service flow of durable goods consumption to be a constant fraction of the stock, we study a consumption-based asset pricing model featuring time-varying utilization of durable goods. We propose an innovative measure of the unobserved usage of durable goods from carbon dioxide emissions. We find that the time-varying utilization of durable goods is a valid pricing factor. Our model exhibits a stronger cross-sectional pricing power than several consumption-based capital asset pricing models, including Yogo’s (2006) durable goods model. Finally, our model mitigates the joint risk premium and implied risk-free rate puzzle.
We are grateful for helpful comments to Bernard Dumas (the editor), the anonymous referees, Snehal Banerjee, Jules van Binsbergen, Rui Cui, Zhi Da, Pengjie Gao, Kathleen Hagerty, Ravi Jagannathan, Andrew Karolyi, Robert Korajczyk, Arvind Krishnamurthy, Deborah Lucas (discussant), Paulo Maio (discussant), Dimitris Papanikolaou, Zhaogang Song, Ilias Tsiakas (discussant), Annette Vissing-Jorgensen, Motohiro Yogo, Jiangfeng Yu, Hayong Yun, Shaojun Zhang (discussant). We also thank seminar participants at the 2014 China International Conference in Finance, the 40th European Finance Association Annual Conference, the 2013 Financial Management Association Annual Meeting and the Doctoral Consortium, the 26th Australasian Finance and Banking Conference and the Ph.D. Forum, Cornerstone Research, Georgetown University, INSEAD, the University of Melbourne, University of New South Wales, PBC School of Finance Tsinghua University, and the Kellogg finance baglunch. Zhuo Chen gratefully acknowledge the support from Minsheng Wealth Management Research Center at Tsinghua University. Any errors belong to the authors.