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

47 Pages Posted: 16 Aug 2012 Last revised: 19 Feb 2016

See all articles by Zhuo Chen

Zhuo Chen

Tsinghua University; Tsinghua University - PBC School of Finance

Andrea Lu

The University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Date Written: April 15, 2015

Abstract

Although it may be difficult for households to instantaneously adjust their stock of durable goods, they have much more latitude in adjusting the service flow from that stock. In contrast to past studies that assume service flow to be a constant fraction of the stock, we model the utilization of the stock of durable goods to be time-varying. We propose an innovative measure of the unobserved usage of durable goods from carbon dioxide emissions. Emissions provide a convenient aggregation of energy consumption that has become an important complementary input for durable goods consumption in recent decades. 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 the CAPM and several consumption-based capital asset pricing models (CCAPMs), including Yogo's (2006) durable good 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

JEL Classification: G12, Q43

Suggested Citation

Chen, Zhuo and Lu, Andrea Y., Seeing the Unobservable from the Invisible:The Role of CO2 in Measuring Consumption Risk (April 15, 2015). PBCSF-NIFR Research Paper No. 12-03. Available at SSRN: https://ssrn.com/abstract=2130823 or http://dx.doi.org/10.2139/ssrn.2130823

Zhuo Chen

Tsinghua University ( email )

43 Chengfu Road
Beijing, 100083
China

Tsinghua University - PBC School of Finance

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Andrea Y. Lu (Contact Author)

The University of Melbourne - Department of Finance ( email )

Level 12, 198 Berkeley Street
Parkville, Victoria 3010 3010
Australia
+61383443326 (Phone)
+61383446914 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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