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Investment decision making under deep uncertainty -- application to climate change

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  • Hallegatte, Stephane
  • Shah, Ankur
  • Lempert, Robert
  • Brown, Casey
  • Gill, Stuart

Abstract

While agreeing on the choice of an optimal investment decision is already difficult for any diverse group of actors, priorities, and world views, the presence of deep uncertainties further challenges the decision-making framework by questioning the robustness of all purportedly optimal solutions. This paper summarizes the additional uncertainty that is created by climate change, and reviews the tools that are available to project climate change (including downscaling techniques) and to assess and quantify the corresponding uncertainty. Assuming that climate change and other deep uncertainties cannot be eliminated over the short term (and probably even over the longer term), it then summarizes existing decision-making methodologies that are able to deal with climate-related uncertainty, namely cost-benefit analysis under uncertainty, cost-benefit analysis with real options, robust decision making, and climate informed decision analysis. It also provides examples of applications of these methodologies, highlighting their pros and cons and their domain of applicability. The paper concludes that it is impossible to define the"best"solution or to prescribe any particular methodology in general. Instead, a menu of methodologies is required, together with some indications on which strategies are most appropriate in which contexts. This analysis is based on a set of interviews with decision-makers, in particular World Bank project leaders, and on a literature review on decision-making under uncertainty. It aims at helping decision-makers identify which method is more appropriate in a given context, as a function of the project's lifetime, cost, and vulnerability.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6193.

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Date of creation: 01 Sep 2012
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Handle: RePEc:wbk:wbrwps:6193

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Keywords: Climate Change Economics; Climate Change Mitigation and Green House Gases; Science of Climate Change; Global Environment Facility; Water Supply and Sanitation Governance and Institutions;

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References

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  1. repec:hal:wpaper:hal-00522404 is not listed on IDEAS
  2. repec:reg:wpaper:615 is not listed on IDEAS
  3. Heal, Geoffrey, 2005. "Intertemporal Welfare Economics and the Environment," Handbook of Environmental Economics, Elsevier, in: K. G. Mäler & J. R. Vincent (ed.), Handbook of Environmental Economics, edition 1, volume 3, chapter 21, pages 1105-1145 Elsevier.
  4. Robert J. Lempert & David G. Groves & Steven W. Popper & Steve C. Bankes, 2006. "A General, Analytic Method for Generating Robust Strategies and Narrative Scenarios," Management Science, INFORMS, INFORMS, vol. 52(4), pages 514-528, April.
  5. Hoyt Bleakley & Jeffrey Lin, 2010. "Portage: Path Dependence and Increasing Returns in U.S. History," NBER Working Papers 16314, National Bureau of Economic Research, Inc.
  6. Pindyck, Robert S., 2002. "Optimal timing problems in environmental economics," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 26(9-10), pages 1677-1697, August.
  7. Henry, Claude, 1974. "Investment Decisions Under Uncertainty: The "Irreversibility Effect."," American Economic Review, American Economic Association, American Economic Association, vol. 64(6), pages 1006-12, December.
  8. Harvey, Charles M., 1994. "The reasonableness of non-constant discounting," Journal of Public Economics, Elsevier, Elsevier, vol. 53(1), pages 31-51, January.
  9. Hypatia Nassopoulos & Patrice Dumas & Stéphane Hallegatte, 2012. "Adaptation to an uncertain climate change: cost benefit analysis and robust decision making for dam dimensioning," Climatic Change, Springer, Springer, vol. 114(3), pages 497-508, October.
  10. Ha-Duong, Minh, 1998. "Quasi-option value and climate policy choices," Energy Economics, Elsevier, Elsevier, vol. 20(5-6), pages 599-620, December.
  11. Martin L. Weitzman, 2009. "On Modeling and Interpreting the Economics of Catastrophic Climate Change," The Review of Economics and Statistics, MIT Press, vol. 91(1), pages 1-19, February.
  12. Hallegatte, Stephane, 2011. "How economic growth and rational decisions can make disaster losses grow faster than wealth," Policy Research Working Paper Series 5617, The World Bank.
  13. repec:reg:ranaly:184 is not listed on IDEAS
  14. Gollier, Christian & Treich, Nicolas, 2003. " Decision-Making under Scientific Uncertainty: The Economics of the Precautionary Principle," Journal of Risk and Uncertainty, Springer, Springer, vol. 27(1), pages 77-103, August.
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Cited by:
  1. Dethier, Jean-Jacques & Morrill, Curtis, 2012. "The great recession and the future of cities," Policy Research Working Paper Series 6256, The World Bank.
  2. Hallegatte, Stephane, 2012. "An exploration of the link between development, economic growth, and natural risk," Policy Research Working Paper Series 6216, The World Bank.
  3. Lempert, Robert & Kalra, Nidhi & Peyraud, Suzanne & Mao, Zhimin & Tan, Sinh Bach & Cira, Dean & Lotsch, Alexander, 2013. "Ensuring robust flood risk management in Ho Chi Minh city," Policy Research Working Paper Series 6465, The World Bank.
  4. World Bank, 2012. "Inclusive Green Growth : The Pathway to Sustainable Development," World Bank Publications, The World Bank, number 6058, August.
  5. Bonzanigo, Laura & Kalra, Nidhi, 2014. "Making informed investment decisions in an uncertain world : a short demonstration," Policy Research Working Paper Series 6765, The World Bank.

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