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Risk-adjusted gamma discounting

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  • Weitzman, Martin L.

Abstract

It is widely recognized that the economics of distant-future events, like climate change, is critically dependent upon the choice of a discount rate. Unfortunately, it is unclear how to discount distant-future events when the future discount rate itself is unknown. In previous work, an analytically-tractable approach called "gamma discounting" was proposed, which gave a declining discount rate schedule as a simple closed-form function of time. This paper extends the previous gamma approach by using a Ramsey optimal growth model, combined with uncertainty about future productivity, in order to "risk adjust" all probabilities by marginal utility weights. Some basic numerical examples are given, which suggest that the overall effect of risk-adjusted gamma discounting on lowering distant-future discount rates may be significant. The driving force is a "fear factor" from risk aversion to permanent productivity shocks representing catastrophic future states of the world.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Environmental Economics and Management.

Volume (Year): 60 (2010)
Issue (Month): 1 (July)
Pages: 1-13

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Handle: RePEc:eee:jeeman:v:60:y:2010:i:1:p:1-13

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Web page: http://www.elsevier.com/locate/inca/622870

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Keywords: Discounting Risk-adjusted Distant future Gamma discounting Climate change;

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References

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  1. Weitzman, Martin L., 2009. "Additive Damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting," Economics Discussion Papers, Kiel Institute for the World Economy 2009-26, Kiel Institute for the World Economy.
  2. Gollier, Christian & Weitzman, Martin, 2009. "How Should the Distant Future be Discounted When Discount Rates are Uncertain?," TSE Working Papers, Toulouse School of Economics (TSE) 09-107, Toulouse School of Economics (TSE).
  3. Phoebe Koundouri & Theologos Pantelidis & Ben Groom & Ekaterini Panopoulou, 2007. "Discounting the distant future: How much does model selection affect the certainty equivalent rate?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 22(3), pages 641-656.
  4. Gollier, Christian, 2009. "Should we Discount the Far-Distant Future at its Lowest Possible Rate?," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, Kiel Institute for the World Economy, vol. 3(25), pages 1-14.
  5. Weitzman, Martin L., 2009. "On Modeling and Interpreting the Economics of Catastrophic Climate Change," Scholarly Articles 3693423, Harvard University Department of Economics.
  6. Martin L. Weitzman, 2001. "Gamma Discounting," American Economic Review, American Economic Association, American Economic Association, vol. 91(1), pages 260-271, March.
  7. Partha Dasgupta, 2008. "Discounting climate change," Journal of Risk and Uncertainty, Springer, Springer, vol. 37(2), pages 141-169, December.
  8. Weitzman, Martin L., 2009. "Additive Damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting," Scholarly Articles 9639963, Harvard University Department of Economics.
  9. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, Elsevier, vol. 36(3), pages 201-208, November.
  10. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 45(3), pages 686-702, September.
  11. Hepburn, Cameron & Groom, Ben, 2007. "Gamma discounting and expected net future value," Journal of Environmental Economics and Management, Elsevier, Elsevier, vol. 53(1), pages 99-109, January.
  12. Newell, Richard G. & Pizer, William A., 2004. "Uncertain discount rates in climate policy analysis," Energy Policy, Elsevier, Elsevier, vol. 32(4), pages 519-529, March.
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Citations

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Cited by:
  1. Christian Gollier, 2012. "Evaluation of Long-Dated Investments under Uncertain Growth Trend, Volatility and Catastrophes," CESifo Working Paper Series, CESifo Group Munich 4052, CESifo Group Munich.
  2. Gollier, Christian, 2012. "Asset pricing with uncertain betas: A long-term perspective," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 752, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Geoffrey Heal & Antony Millner, 2013. "Discounting under Disagreement," NBER Working Papers 18999, National Bureau of Economic Research, Inc.
  4. Gollier, Christian, 2012. "A theory of rational short-termism with uncertain betas," LERNA Working Papers, LERNA, University of Toulouse 12.14.371, LERNA, University of Toulouse.
  5. Weitzman, Martin L., 2011. "Revisiting Fat-Tailed Uncertainty in the Economics of Climate Change," Scholarly Articles 11130443, Harvard University Department of Economics.
  6. Boyarchenko, Svetlana & Levendorskii, Sergei, 2010. "Discounting when income is stochastic and climate change policies," MPRA Paper 27998, University Library of Munich, Germany.
  7. Morgenroth, Edgar, 2011. "How Can We Improve Evaluation Methods for Public Infrastructure?," Papers, Economic and Social Research Institute (ESRI) EC2, Economic and Social Research Institute (ESRI).
  8. Munnich Vass, Miriam & Elofsson, Katarina, 2013. "Is forest sequestration at the expense of bioenergy and forest products cost-effective in EU climate policy to 2050?," Working Paper Series, Department Economics, Swedish University of Agricultural Sciences 2013:9, Department Economics, Swedish University of Agricultural Sciences.
  9. Andrew Meyer, 2013. "Intertemporal Valuation of River Restoration," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 54(1), pages 41-61, January.
  10. Gollier, Christian, 2014. "Gamma discounters are short-termist," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 828, Institut d'Économie Industrielle (IDEI), Toulouse.
  11. Johansson-Stenman, Olof & Sterner, Thomas, 2013. "Discounting and Relative Consumption," Working Papers in Economics, University of Gothenburg, Department of Economics 559, University of Gothenburg, Department of Economics.

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