Environmental Protection, Rare Disasters, and Discount Rates
AbstractExtremely low discount rates play a central role in the Stern Review’s evaluation of environmental protection, and this assumption has been criticized by many economists. The Review also stresses that great uncertainty is a critical element for optimal environmental policies. An appropriate model for this policy analysis requires sufficient risk aversion and fattailed uncertainty to get into the ballpark of explaining the observed equity premium. A satisfactory framework, based on Epstein-Zin/Weil preferences, also separates the coefficient of relative risk aversion (important for results on environmental investment) from the intertemporal elasticity of substitution for consumption (which matters little). Calibrations based on existing models of rare macroeconomic disasters suggest that optimal environmental investment can be a significant share of GDP even with reasonable values for the rate of time preference and the expected rate of return on private capital. The key parameters, yet to be pinned down, are the proportionate effect of environmental investment on the probability of environmental disaster and the baseline probability of environmental disaster.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19258.
Date of creation: Jul 2013
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- E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- Q5 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-07-28 (All new papers)
- NEP-ENE-2013-07-28 (Energy Economics)
- NEP-ENV-2013-07-28 (Environmental Economics)
- NEP-MAC-2013-07-28 (Macroeconomics)
- NEP-RES-2013-07-28 (Resource Economics)
- NEP-UPT-2013-07-28 (Utility Models & Prospect Theory)
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- Nicholas Stern, 2013. "Ethics, equity and the economics of climate change. Paper 2: Economics and Politics," Grantham Research Institute on Climate Change and the Environment Working Papers 84b, Grantham Research Institute on Climate Change and the Environment.
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