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Discounting and Uncertainty in Climate Change Policy Analysis

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  • Richard B. Howarth

Abstract

Economic studies of climate change commonly discount the future at a rate equal to the long-run return on corporate stocks. Stock market returns, however, are dominated by a risk premium, while climate change mitigation measures would reduce important risks to future welfare. Drawing on the theory of investment behavior under uncertainty, this paper argues that the benefits of climate stabilization policies should be discounted at a rate equal to the annual return on risk-free financial assets, which attains an empirical value between 0 and 2.6%. In addition, expected benefits must be adjusted to account for the value of risk abatement.

Suggested Citation

  • Richard B. Howarth, 2003. "Discounting and Uncertainty in Climate Change Policy Analysis," Land Economics, University of Wisconsin Press, vol. 79(3), pages 369-381.
  • Handle: RePEc:uwp:landec:v:79:y:2003:i:3:p:369-381
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    References listed on IDEAS

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    Cited by:

    1. Maria Sandsmark & Haakon Vennemo, 2007. "A portfolio approach to climate investments: CAPM and endogenous risk," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 37(4), pages 681-695, August.
    2. Hof, Andries F. & van Vuuren, Detlef P. & den Elzen, Michel G.J., 2010. "A quantitative minimax regret approach to climate change: Does discounting still matter?," Ecological Economics, Elsevier, vol. 70(1), pages 43-51, November.
    3. repec:eee:jeeman:v:87:y:2018:i:c:p:258-274 is not listed on IDEAS
    4. Simon Dietz & Christian Gollier & Louise Kessler, 2015. "The climate beta," GRI Working Papers 190, Grantham Research Institute on Climate Change and the Environment.
    5. Morrissey, J. & Meyrick, B. & Sivaraman, D. & Horne, R.E. & Berry, M., 2013. "Cost-benefit assessment of energy efficiency investments: Accounting for future resources, savings and risks in the Australian residential sector," Energy Policy, Elsevier, vol. 54(C), pages 148-159.
    6. Frank Ackerman & Elizabeth Stanton & Ramón Bueno, 2013. "Epstein–Zin Utility in DICE: Is Risk Aversion Irrelevant to Climate Policy?," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 56(1), pages 73-84, September.
    7. Venkatachalam, L., 2008. "Behavioral economics for environmental policy," Ecological Economics, Elsevier, vol. 67(4), pages 640-645, November.
    8. W. Botzen & Jeroen Bergh, 2014. "Specifications of Social Welfare in Economic Studies of Climate Policy: Overview of Criteria and Related Policy Insights," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 58(1), pages 1-33, May.
    9. Johansson-Stenman, Olof, 2010. "Health Investments Under Risk And Ambiguity," Working Papers in Economics 443, University of Gothenburg, Department of Economics.
    10. Andries Hof & Chris Hope & Jason Lowe & Michael Mastrandrea & Malte Meinshausen & Detlef Vuuren, 2012. "The benefits of climate change mitigation in integrated assessment models: the role of the carbon cycle and climate component," Climatic Change, Springer, vol. 113(3), pages 897-917, August.
    11. Frank Ackerman & Ian J. Finlayson, "undated". "06-07 “The Economics of Inaction on Climate Change: A Sensitivity Analysis”," GDAE Working Papers 06-07, GDAE, Tufts University.
    12. Camilla Froyn, 2005. "Decision Criteria, Scientific Uncertainty, and the Globalwarming Controversy," Mitigation and Adaptation Strategies for Global Change, Springer, vol. 10(2), pages 183-211, April.
    13. Liu, Liqun, 2012. "Inferring the rate of pure time preference under uncertainty," Ecological Economics, Elsevier, vol. 74(C), pages 27-33.
    14. Laurie Johnson & Chris Hope, 2012. "The social cost of carbon in U.S. regulatory impact analyses: an introduction and critique," Journal of Environmental Studies and Sciences, Springer;Association of Environmental Studies and Sciences, vol. 2(3), pages 205-221, September.
    15. Scrieciu, S. Şerban & Barker, Terry & Ackerman, Frank, 2013. "Pushing the boundaries of climate economics: critical issues to consider in climate policy analysis," Ecological Economics, Elsevier, vol. 85(C), pages 155-165.
    16. Gutrich, John & Howarth, Richard B., 2007. "Carbon sequestration and the optimal management of New Hampshire timber stands," Ecological Economics, Elsevier, vol. 62(3-4), pages 441-450, May.
    17. Kjell Arne Brekke & Olof Johansson-Stenman, 2008. "The behavioural economics of climate change," Oxford Review of Economic Policy, Oxford University Press, vol. 24(2), pages 280-297, Summer.
    18. Kousky, Carolyn & Kopp, Robert E. & Cooke, Roger M., 2011. "Risk premia and the social cost of carbon: A review," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 5, pages 1-24.
    19. Richard B. Howarth, 2004. "Against High Interest Rates," Rensselaer Working Papers in Economics 0404, Rensselaer Polytechnic Institute, Department of Economics.
    20. John Gowdy & Roxana Juliá, 2010. "Global Warming Economics in the Long Run: A Conceptual Framework," Land Economics, University of Wisconsin Press, vol. 86(1), pages 117-130.
    21. repec:eee:juipol:v:48:y:2017:i:c:p:210-218 is not listed on IDEAS

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    JEL classification:

    • Q21 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Demand and Supply; Prices

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