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Structural Uncertainty and the Value of Statistical Life in the Economics of Catastrophic Climate Change

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Martin Weitzman

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Abstract

Using climate change as a prototype motivating example, this paper analyzes the implications of structural uncertainty for the economics of low-probability high-impact catastrophes. The paper shows that having an uncertain multiplicative parameter, which scales or amplifies exogenous shocks and is updated by Bayesian learning, induces a critical "tail fattening" of posterior-predictive distributions. These fattened tails can have strong implications for situations (like climate change) where a catastrophe is theoretically possible because prior knowledge cannot place sufficiently narrow bounds on overall damages. The essence of the problem is the difficulty of learning extreme-impact tail behavior from finite data alone. At least potentially, the influence on cost-benefit analysis of fat-tailed uncertainty about the scale of damages -- coupled with a high value of statistical life -- can outweigh the influence of discounting or anything else.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13490.

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Date of creation: Oct 2007
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Handle: RePEc:nbr:nberwo:13490

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Find related papers by JEL classification:
Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Robert E Hall & Charles I Jones, 2007. "The Value of Life and the Rise in Health Spending," The Quarterly Journal of Economics, MIT Press, vol. 122(1), pages 39-72, 02. [Downloadable!] (restricted)
    Other versions:
  2. W. Kip Viscusi & Joseph E. Aldy, 2003. "The Value of a Statistical Life: A Critical Review of Market Estimates throughout the World," NBER Working Papers 9487, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Martin L. Weitzman, 2007. "Subjective Expectations and Asset-Return Puzzles," American Economic Review, American Economic Association, vol. 97(4), pages 1102-1130, September.
  4. Aumann, Robert J & Kurz, Mordecai, 1977. "Power and Taxes," Econometrica, Econometric Society, vol. 45(5), pages 1137-61, July. [Downloadable!] (restricted)
  5. Geweke, John, 2001. "A note on some limitations of CRRA utility," Economics Letters, Elsevier, vol. 71(3), pages 341-345, June. [Downloadable!] (restricted)
  6. Jérôme Foncel & Nicolas Treich, 2005. "Fear of Ruin," Journal of Risk and Uncertainty, Springer, vol. 31(3), pages 289-300, December. [Downloadable!] (restricted)
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  1. Geoffrey Heal, 2008. "Climate Economics: A Meta-Review and Some Suggestions," NBER Working Papers 13927, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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