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Seeing the Unobservable from the Invisible: The Role of CO2 in Measuring Consumption Risk

Zhuo Chen and Andrea Lu

Review of Finance, 2018, vol. 22, issue 3, 977-1009

Abstract: 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.

Keywords: Consumption-based capital asset pricing model (CCAPM); Durable goods service flow; Carbon dioxide emissions (search for similar items in EconPapers)
Date: 2018
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