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Understanding Energy Investment Discount Rates through CAPM

This research by Xiaomei (Barbara) Chen from NCSU examines the implications of the Capital Asset Pricing Model (CAPM) on discount rates for energy investments. It explores how commodity prices, especially energy prices, and risk premiums fluctuate weekly, impacting the discounting of energy investments. Various notations and fitted models are used to predict risk premiums for energy futures such as propane, crude oil, gasoline, heating oil, natural gas, and coal.

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Understanding Energy Investment Discount Rates through CAPM

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  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 • Rate of time preference • Economic growth • Risk premium

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

  5. Some Notations • Energy futures return: • Risk-free asset return • Risk Premium: • Commodity beta: • CAPM Predicted Risk Premium:

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

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

  8. CAPM Predicted Risk Premium Crude Oil Futures 1985 1990 1995 2000 2005 2010

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