Carbon Dioxide Emissions and Asset Pricing

Abstract

In the modern world, where our lives are heavily dependent on energy consumption, almost all types of consumption involve emissions of carbon dioxide. In this paper, we propose the growth rate of carbon dioxide emissions as a new measure of consumption growth under the standard consumption-based asset pricing (CCAPM) framework. The growth rate of CO2 emissions contributes to the measurement of consumption growth by o ering a more comprehensive coverage of consumption, given its unique advantage of being able to incorporate the transportation and housing component of household consumption. Using the annual growth rate of per capita CO2 emissions as a proxy for the consumption growth under the CCAPM framework, we achieve an estimated relative risk aversion of 5.91, and an implied annual real risk-free rate of 2.18%. In addition, the CO2-based consumption growth captures the consumption risk very well that it explains the cross-sectional variation in excess returns of the US stock portfolios with a small insigni cant pricing error of 0.49 basis point per year.