Monday, August 11, 2008

How much should gas prices be capitalized into SUV values?

Let us say that the baseline car gets 20 mpg, and an SUV gets 13 mpg (this is for in-town driving). If the average person drives 15,000 miles per year, this means the SUV driver uses about 400 gallons per year more than the baseline car. Let us suppose the equilibrium price was determined when gas was $2 per gallon.

Now that gas is $4 per gallon, the SUV driver is paying $800 per year more relative to the baseline car than expected. Suppose the real discount rate for a car is .05, and that cars depreciate on a straight-line basis over 10 years. This means that SUV values should fall by $800/.15 or about $5300. Seems to work....


light said...

I'm wondering how you got the real discount rate.

I am thinking that the discount rate would be based upon the volatility of real gas prices, not car prices. How did you calculate the risk premium?

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