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.

We evaluate the performance of various methods for estimating factor returns in an approximate factor model. Differences across estimators are most pronounced when there is cross-sectional heteroscedasticity or when cross-sectional sample sizes, n, have fewer than 4,000 assets. Estimators incorporating either cross-sectional or time-series heteroscedasticity outperform the other estimators when those types of heteroscedasticity are present. The differences are most pronounced when the cross-sectional sample is small. Received December 2, 2015; editorial decision May 16, 2017 by Editor Jeffrey Pontiff.