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Environmental Protection, Rare Disasters and Discount Rates

Author

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  • Robert J. Barro

Abstract

type="main" xml:id="ecca12117-abs-0001"> The Stern Review's evaluation of environmental protection stresses low discount rates and uncertainty about environmental effects. An appropriate model for analysing this uncertainty and the associated discount rates requires sufficient risk aversion and fat-tailed uncertainty to account for the observed equity premium. Calibrations based on Epstein–Zin preferences and existing analyses of rare macroeconomic disasters suggest that optimal environmental investment can be a significant share of GDP even with reasonable rates of time preference. Optimal environmental investment increases with risk aversion and the probability and typical size of environmental disasters, but decreases with uncertainty about policy effectiveness.

Suggested Citation

  • Robert J. Barro, 2015. "Environmental Protection, Rare Disasters and Discount Rates," Economica, London School of Economics and Political Science, vol. 82(325), pages 1-23, January.
  • Handle: RePEc:bla:econom:v:82:y:2015:i:325:p:1-23
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    File URL: http://hdl.handle.net/10.1111/ecca.2014.82.issue-325
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    References listed on IDEAS

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    1. Yongyang Cai & Kenneth L. Judd & Thomas S. Lontzek, 2013. "The Social Cost of Stochastic and Irreversible Climate Change," NBER Working Papers 18704, National Bureau of Economic Research, Inc.
    2. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    3. Robert J. Barro, 2006. "Rare Disasters and Asset Markets in the Twentieth Century," The Quarterly Journal of Economics, Oxford University Press, vol. 121(3), pages 823-866.
    4. Robert J. Barro, 2009. "Rare Disasters, Asset Prices, and Welfare Costs," American Economic Review, American Economic Association, vol. 99(1), pages 243-264, March.
    5. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
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    Cited by:

    1. Ian W. R. Martin & Robert S. Pindyck, 2015. "Averting Catastrophes: The Strange Economics of Scylla and Charybdis," American Economic Review, American Economic Association, vol. 105(10), pages 2947-2985, October.
    2. Mariia Belaia & Michael Funke & Nicole Glanemann, 2017. "Global Warming and a Potential Tipping Point in the Atlantic Thermohaline Circulation: The Role of Risk Aversion," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 67(1), pages 93-125, May.
    3. Motoyama, Takumi, 2017. "Optimal disaster-preventive expenditure in a dynamic and stochastic model," Journal of Macroeconomics, Elsevier, vol. 51(C), pages 28-47.
    4. repec:kap:compec:v:51:y:2018:i:3:d:10.1007_s10614-016-9635-7 is not listed on IDEAS
    5. repec:kap:enreec:v:67:y:2017:i:3:d:10.1007_s10640-016-0033-3 is not listed on IDEAS
    6. repec:eee:macchp:v2-1893 is not listed on IDEAS
    7. Antti Simola & Juntunen, Janne & Meriläinen, Päivi, 2016. "Contaminants and pathogens in waterways - economic assessment of risks," EcoMod2016 9442, EcoMod.
    8. Martin L. Weitzman, 2014. "Fat Tails and the Social Cost of Carbon," American Economic Review, American Economic Association, vol. 104(5), pages 544-546, May.
    9. Nicholas Stern, 2013. "Ethics, equity and the economics of climate change. Paper 2: Economics and Politics," GRI Working Papers 84b, Grantham Research Institute on Climate Change and the Environment.
    10. Giglio, Stefano & Maggiori, Matteo & Stroebel, Johannes, 2014. "Very long-run discount rates," Globalization and Monetary Policy Institute Working Paper 182, Federal Reserve Bank of Dallas.
    11. Rick van der Ploeg & Aart de Zeeuw, 2018. "Pricing Carbon and Adjusting Capital to Fend off Climate Catastrophes," OxCarre Working Papers 207, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    12. Besley, Timothy J. & Dixit, Avinash K., 2017. "Comparing Alternative Policies Against Environmental Catastrophes," CEPR Discussion Papers 11802, C.E.P.R. Discussion Papers.
    13. Christoph M. Rheinberger & Nicolas Treich, 2017. "Attitudes Toward Catastrophe," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 67(3), pages 609-636, July.

    More about this item

    JEL classification:

    • 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

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