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

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Presentation on theme: "Energy Prices Confront CAPM: Implications for Discount Rates Xiaomei (Barbara) Chen NCSU."— Presentation transcript:

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

2 What discount rate should be used for evaluating energy investments?

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

4 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

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

6 Fitted Model: y = 0.17 + 1.69 x (0.09) (0.40) Energy Futures Propane Crude Oil Gasoline Heating Oil Natural Gas Coal

7 Fitted Model: y = 0.17 + 1.12 x (0.12) (0.31) Crude Oil Futures

8 198519901995200020052010 CAPM Predicted Risk Premium

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