Energy Prices Confront CAPM: Implications for Discount Rates Xiaomei (Barbara) Chen NCSU.

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Presentation transcript:

Energy Prices Confront CAPM: Implications for Discount Rates Xiaomei (Barbara) Chen NCSU

What discount rate should be used for evaluating energy investments?

Discount Rate 1. Rate of time preference 2. Economic growth 3. Risk premium

1. CAPM (Capital Asset Pricing Model) helps explain commodity prices ◦ Especially energy prices ◦ Risk premiums vary weekly 2. An unusually powerful test of CAPM 3. It matters for discounting energy investment Three Points

1. Energy futures return: 2. Risk-free asset return 3. Risk Premium: 4. Commodity beta: 5. CAPM Predicted Risk Premium: Some Notations

Fitted Model: y = x (0.09) (0.40) Energy Futures Propane Crude Oil Gasoline Heating Oil Natural Gas Coal

Fitted Model: y = x (0.12) (0.31) Crude Oil Futures

CAPM Predicted Risk Premium

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