IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Why uncertainty matters - discounting under intertemporal risk aversion and ambiguity

  • Traeger, Christian P

    ()

    (University of California, Berkeley. Dept of agricultural and resource economics)

Uncertainty has an almost negligible impact on project value in the economicstandard model. I show that a comprehensive evaluation of uncertainty and uncertainty attitude changes this picture fundamentally. The analysis relies on the discount rate, which is the crucial determinant in balancing immediate costs against future benefits and the single most important determinant of optimal mitigation policies in the integrated assessment of climate change. The paper examines two shortcomings in the recent debate and the current models addressing climate change assessment. First, removing an implicit assumption of (intertemporal) risk neutrality reduces the growth effect in social discounting and significantly amplifies the importance of risk and correlation. Second, debate and models largely overlook the difference in attitude with respect to risk and with respect to non-risk uncertainty. The paper derives the resulting changes of the risk-free and the stochastic social discount rate and points out the importance of even thin tailed uncertainty for climate change evaluation. It discusses combinations ofuncertainty and correlation that reduce the social discount rate to pure preference. In a theoretical contribution, the paper extends the smooth ambiguity model by providing a threefold disentanglement between, risk aversion, ambiguity aversion, and the propensityto smooth consumption over time.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.escholarship.org/uc/item/2w614303
Download Restriction: no

Paper provided by University of California at Berkeley, Department of Agricultural and Resource Economics and Policy in its series CUDARE Working Paper Series with number 1092R2.

as
in new window

Length: 41 pages
Date of creation: Dec 2008
Date of revision: Jan 2012
Handle: RePEc:are:cudare:1092r2
Contact details of provider: Postal:
207 Giannini Hall #3310, Berkeley, CA 94720-3310

Phone: (510) 642-3345
Fax: (510) 643-8911
Web page: http://areweb.berkeley.edu/library/Main/CUDARE

More information through EDIRC

Order Information: Postal: University of California, Giannini Foundation of Agricultural Economics Library, 248 Giannini Hall #3310, Berkeley CA 94720-3310
Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Hoel, Michael & Karp, Larry, 2000. "Taxes and Quotas for a Stock Pollutant with Multiplicative Uncertainty," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt9v86p5s7, Department of Agricultural & Resource Economics, UC Berkeley.
  2. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  3. Charles Figuières & Mabel Tidball, 2006. "Sustainable exploitation of a natural resource: a satisfying use of Chichilnisky's criterion," Working Papers 06-03, LAMETA, Universtiy of Montpellier, revised Sep 2006.
  4. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
  5. Garth Heutel, 2012. "How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(2), pages 244-264, April.
  6. Sujoy Mukerji & Peter Klibanoff, 2002. "A Smooth Model of Decision,Making Under Ambiguity," Economics Series Working Papers 113, University of Oxford, Department of Economics.
  7. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, 08.
  8. 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.
  9. Luc LAUWERS, 2010. "Intergenerational equity, efficiency and constructability," Working Papers Department of Economics ces10.22, KU Leuven, Faculty of Economics and Business, Department of Economics.
  10. Kelly, David L. & Kolstad, Charles D., 2001. "Malthus and Climate Change: Betting on a Stable Population," Journal of Environmental Economics and Management, Elsevier, vol. 41(2), pages 135-161, March.
  11. Gollier, Christian, 2002. "Discounting an uncertain future," Journal of Public Economics, Elsevier, vol. 85(2), pages 149-166, August.
  12. John Y. Campbell, 1993. "Understanding Risk and Return," NBER Working Papers 4554, National Bureau of Economic Research, Inc.
  13. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  14. Martin L. Weitzman, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 703-724, September.
  15. Traeger, Christian P., 2010. "Intertemporal risk aversion – or – wouldn’t it be nice to tell whether Robinson Crusoe is risk averse?," CUDARE Working Paper Series 1102, University of California at Berkeley, Department of Agricultural and Resource Economics and Policy.
  16. Graciela Chichilnisky, 2012. "Economic theory and the global environment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 49(2), pages 217-225, February.
  17. Weitzman, Martin L., 2009. "Additive Damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting," Scholarly Articles 9639963, Harvard University Department of Economics.
  18. Nengjiu Ju & Jianjun Miao, . "Ambiguity, Learning, and Asset Returns," Boston University - Department of Economics - Working Papers Series wp2009-014, Boston University - Department of Economics.
  19. Ghirardato, Paolo & Maccheroni, Fabio & Marinacci, Massimo, 2004. "Differentiating ambiguity and ambiguity attitude," Journal of Economic Theory, Elsevier, vol. 118(2), pages 133-173, October.
  20. Karp, Larry & Zhang, Jiangfeng, 2006. "Regulation with anticipated learning about environmental damages," Journal of Environmental Economics and Management, Elsevier, vol. 51(3), pages 259-279, May.
  21. Melissa Dell & Benjamin F. Jones & Benjamin A. Olken, 2008. "Climate Change and Economic Growth: Evidence from the Last Half Century," NBER Working Papers 14132, National Bureau of Economic Research, Inc.
  22. Normandin, M. & St-Amour, P., 1996. "Substitution, Risk Aversion, Taste Shocks and Equity Premia," Papers 9606, Laval - Recherche en Politique Economique.
  23. Gierlinger, Johannes & Gollier, Christian, 2008. "Socially Efficient Discounting under Ambiguity Aversion," IDEI Working Papers 561, Institut d'Économie Industrielle (IDEI), Toulouse.
  24. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  25. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
  26. Fabio Maccheroni & Massimo Marinacci & Aldo Rustichini, 2006. "Dynamic Variational Preferences," Carlo Alberto Notebooks 1, Collegio Carlo Alberto.
  27. Hoel, Michael & Karp, Larry, 2002. "Taxes versus quotas for a stock pollutant," Resource and Energy Economics, Elsevier, vol. 24(4), pages 367-384, November.
  28. Robert S. Pindyck, 2010. "Modeling the Impact of Warming in Climate Change Economics," NBER Working Papers 15692, National Bureau of Economic Research, Inc.
  29. Peter Klibanoff & Massimo Marinacci & Sujoy Mukerji, 2006. "Recursive Smooth Ambiguity Preferences," Carlo Alberto Notebooks 17, Collegio Carlo Alberto, revised 2008.
  30. Karp, Larry & Zhang, Jiangfeng, 2008. "Taxes Versus Quantities for a Stock Pollutant with Endogenous Abatement Costs and Asymmetric Information," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt84q0s8tb, Department of Agricultural & Resource Economics, UC Berkeley.
  31. Robert S. Pindyck, 2009. "Uncertain Outcomes and Climate Change Policy," Working Papers 0907, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  32. William D. Nordhaus, 2011. "Estimates of the Social Cost of Carbon: Background and Results from the RICE-2011 Model," Cowles Foundation Discussion Papers 1826, Cowles Foundation for Research in Economics, Yale University.
  33. Itzhak Gilboa & David Schmeidler, 1989. "Maxmin Expected Utility with Non-Unique Prior," Post-Print hal-00753237, HAL.
  34. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  35. Karp, Larry, 2004. "Global Warming and Hyperbolic Discounting," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt5zh730nc, Department of Agricultural & Resource Economics, UC Berkeley.
  36. Plambeck, Erica L. & Hope, Chris & Anderson, John, 1997. "The model: Integrating the science and economics of global warming," Energy Economics, Elsevier, vol. 19(1), pages 77-101, March.
  37. Geir Asheim & Tapan Mitra & Bertil Tungodden, 2012. "Sustainable recursive social welfare functions," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 49(2), pages 267-292, February.
  38. Kelly, David L., 2005. "Price and quantity regulation in general equilibrium," Journal of Economic Theory, Elsevier, vol. 125(1), pages 36-60, November.
  39. Newell, Richard G. & Pizer, William A., 2003. "Regulating stock externalities under uncertainty," Journal of Environmental Economics and Management, Elsevier, vol. 45(2, Supple), pages 416-432, March.
  40. Millner, Antony, 2013. "On welfare frameworks and catastrophic climate risks," Journal of Environmental Economics and Management, Elsevier, vol. 65(2), pages 310-325.
  41. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
  42. Keller, Klaus & Bolker, Benjamin M. & Bradford, D.F.David F., 2004. "Uncertain climate thresholds and optimal economic growth," Journal of Environmental Economics and Management, Elsevier, vol. 48(1), pages 723-741, July.
  43. Ravi Bansal & Dana Kiku & Amir Yaron, 2010. "Long Run Risks, the Macroeconomy, and Asset Prices," American Economic Review, American Economic Association, vol. 100(2), pages 542-46, May.
  44. William D. Nordhaus, 2012. "Economic Policy in the Face of Severe Tail Events," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 14(2), pages 197-219, 03.
  45. Azfar, Omar, 1999. "Rationalizing hyperbolic discounting," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 245-252, February.
  46. Christian Traeger, 2012. "Once Upon a Time Preference - How Rationality and Risk Aversion Change the Rationale for Discounting," CESifo Working Paper Series 3793, CESifo Group Munich.
  47. Geoffrey Heal, 2009. "Climate Economics: A Meta-Review and Some Suggestions for Future Research," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 3(1), pages 4-21, Winter.
  48. Armon Rezai & Duncan Foley & Lance Taylor, 2012. "Global warming and economic externalities," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 49(2), pages 329-351, February.
  49. Melissa Dell & Benjamin F. Jones & Benjamin A. Olken, 2012. "Temperature Shocks and Economic Growth: Evidence from the Last Half Century," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(3), pages 66-95, July.
  50. Kihlstrom, Richard E. & Mirman, Leonard J., 1974. "Risk aversion with many commodities," Journal of Economic Theory, Elsevier, vol. 8(3), pages 361-388, July.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:are:cudare:1092r2. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jeff Cole)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.