Hotelling Confronts CAPM : A Test of the Theory of Exhaustible Resources

A model of pricing of natural-resource commodities that integrates financial and product markets is derived and tested. In the model, price-taking firms extract from a deposit of an exhaustible resource; production is risky, and investors own shares in the mine. Investors can diversify their risk by holding a portfolio of other assets. The model thus unifies two strands of the economic and financial literature: one that builds on the Hotelling model of resource depletion and the other that extends the Capital- Asset-Pricing Model. Tests of the predictions make use of shadow prices that were estimated from a panel of fourteen small Canadian copper mines. The rate of growth of shadow prices is related to technological variables such as the rate of change of costs due to depletion and to financial variables such as the risk-free rate of return, the rate of return on the market portfolio, and the rate of growth of macroeconomic aggregates. Our tests fail to reject the theoretical restrictions that are implied by the Hotelling/CAPM model