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

Author

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  • Zhuo Chen
  • Andrea Lu

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.

Suggested Citation

  • Zhuo Chen & Andrea Lu, 2018. "Seeing the Unobservable from the Invisible: The Role of CO2 in Measuring Consumption Risk," Review of Finance, European Finance Association, vol. 22(3), pages 977-1009.
    • Handle: RePEc:oup:revfin:v:22:y:2018:i:3:p:977-1009.
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    File URL: http://hdl.handle.net/10.1093/rof/rfx027
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    Citations

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    Cited by:

    1. Ashley Lim & Yihui Lan & Sirimon Treepongkaruna, 2020. "Asset pricing and energy consumption risk," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3813-3850, December.
    2. Chen, Qi-An & Li, Huashi & Lin, Jianyi & Yan, Youliang, 2023. "Asset pricing with two types of heterogeneous consumption volatilities in mind: Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 77(C).
    3. Hussain, Tanveer & Shams, Syed, 2022. "Pre-deal differences in corporate social responsibility and acquisition performance," International Review of Financial Analysis, Elsevier, vol. 81(C).
    4. Maio, Paulo & Silva, André C., 2020. "Asset pricing implications of money: New evidence," Journal of Banking & Finance, Elsevier, vol. 120(C).

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