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Ambiguity and climate policy

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  • Antony Millner
  • Simon Dietz
  • Geoffrey Heal

Abstract

Economic evaluation of climate policy traditionally treats uncertainty by appealing to expected utility theory. Yet our knowledge of the impacts of climate policy may not be of sufficient quality to justify probabilistic beliefs. In such circumstances, it has been argued that the axioms of expected utility theory may not be the correct standard of rationality. By contrast, several axiomatic frameworks have recently been proposed that account for ambiguous beliefs. In this paper, we apply static and dynamic versions of a smooth ambiguity model to climate mitigation policy. We obtain a general result on the comparative statics of optimal abatement and ambiguity aversion and illustrate this sufficient condition in some simple examples. We then extend our analysis to a more realistic, dynamic setting, and adapt a well-known empirical model of the climate-economy system to show that the value of emissions abatement increases as ambiguity aversion increases, and that this ‘ambiguity premium’ can in some plausible cases be very large.

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Bibliographic Info

Paper provided by Grantham Research Institute on Climate Change and the Environment in its series Grantham Research Institute on Climate Change and the Environment Working Papers with number 24.

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Date of creation: Aug 2010
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Handle: RePEc:lsg:lsgwps:wp24

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Citations

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Cited by:
  1. repec:gwi:wpaper:2012-08 is not listed on IDEAS
  2. Yu-Fu Chen & Michael Funke & Nicole Glanemann, 2011. "Dark Clouds or Silver Linings? Knightian Uncertainty and Climate Change," Dundee Discussion Papers in Economics 258, Economic Studies, University of Dundee.
  3. Antony Millner, 2013. "On Welfare Frameworks and Catastrophic Climate Risks," CESifo Working Paper Series 4442, CESifo Group Munich.
  4. Duncan Foley & Lance Taylor & Armon Rezai, 2013. "The Social Cost of Carbon Emissions," INET Research Notes 28, Institute for New Economic Thinking (INET).
  5. Martin L. Weitzman, 2012. "A Precautionary Tale of Uncertain Tail Fattening," NBER Working Papers 18144, National Bureau of Economic Research, Inc.
  6. Nicola Ranger & Falk Niehörster, 2011. "Deep uncertainty in long-term hurricane risk: scenario generation and implications for future climate experiments," LSE Research Online Documents on Economics 37587, London School of Economics and Political Science, LSE Library.
  7. Stephen C. Smith & Arun S. Malik, 2012. "Adaptation to Climate Change in Low-Income Countries: Lessons from Current Research and Needs from Future Research," Working Papers 2012-8, The George Washington University, Institute for International Economic Policy.
  8. Lemoine, Derek M. & Traeger, Christian P., 2010. "Tipping points and ambiguity in the economics of climate change," CUDARE Working Paper Series 1111R, University of California at Berkeley, Department of Agricultural and Resource Economics and Policy, revised Dec 2011.
  9. Simon Dietz, 2011. "The treatment of risk and uncertainty in the US Social Cost of Carbon for Regulatory Impact Analysis," Grantham Research Institute on Climate Change and the Environment Working Papers 54, Grantham Research Institute on Climate Change and the Environment.
  10. Dietz, Simon, 2011. "The treatment of risk and uncertainty in the US social cost of carbon for regulatory impact analysis," Economics Discussion Papers 2011-30, Kiel Institute for the World Economy.

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