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Optimal adaptation to uncertain climate change

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  • Guthrie, Graeme

Abstract

Enormous public investment will occur as communities adapt to climate change. Much of this investment will be irreversible and the future benefits are uncertain. The real options embedded in adaptation projects are therefore potentially important and their existence needs to be incorporated into investment decision-making. Standard real options analysis is inadequate for this purpose because the arrival of new climate information is unlikely to conform to the stochastic processes typically used in real options analysis. This paper presents a new framework that reflects current uncertainty about climate change and how that uncertainty might change over time. Optimal investment depends on current beliefs regarding the severity of future climate change, how quickly these beliefs will change in the future, and current economic conditions. Most of the net benefits of optimal investment can be captured if investment timing is decided using a simple alternative decision-making rule.

Suggested Citation

  • Guthrie, Graeme, 2023. "Optimal adaptation to uncertain climate change," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).
    • Handle: RePEc:eee:dyncon:v:151:y:2023:i:c:s0165188923000271
    DOI: 10.1016/j.jedc.2023.104621
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    References listed on IDEAS

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    Cited by:

    1. Chao Li & Xing Su & Chao Fan & Jun Wang & Xiangyu Wang, 2025. "A Sustainable Circular Framework for Financing Infrastructure Climate Adaptation: Integrated Carbon Markets," Papers 2501.08004, arXiv.org, revised Feb 2025.
    2. Zhang, Xiaodi, 2025. "Integrating policy design with agricultural emissions reduction in China: A multi-sector DSGE Approach," Economic Analysis and Policy, Elsevier, vol. 86(C), pages 2019-2048.
    3. Zhang, Jiannan & Fan, Kun & Jin, Zhuo & Zhang, Nan, 2025. "Optimal timing of green technology adoption for climate risk mitigation," Insurance: Mathematics and Economics, Elsevier, vol. 125(C).
    4. Kodama, Wataru & Friederichs, Petra & Nematbakhsh, Amin & Odening, Martin & Szemkus,Svenja & Seifert, Stefan & Hüttel, Silke, 2025. "Adaptation Decisions under Climate Change Uncertainty and Weather Extremes," EconStor Preprints 330341, ZBW - Leibniz Information Centre for Economics.

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    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • R42 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Transportation Economics - - - Government and Private Investment Analysis; Road Maintenance; Transportation Planning

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