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Dark Clouds or Silver Linings? Knightian Uncertainty and Climate Change

  • Yu-Fu Chen
  • Michael Funke
  • Nicole Glanemann

This paper examines the impact of Knightian uncertainty upon optimal climate policy through the prism of a continuous-time real option modelling framework. We analytically determine optimal intertemporal climate policies under ambiguity. Additionally, numerical simulations are provided to illustrate the properties of the model. The results indicate that increasing Knightian uncertainty accelerates climate policy, i.e. policymakers become more reluctant to postpone the timing of climate policies into the future.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2011/wp-cesifo-2011-07/cesifo1_wp3516.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3516.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3516
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  1. Weitzman, Martin L., 2009. "Additive Damages, Fat-Tailed Climate Dynamics, and Uncertain Discounting," Scholarly Articles 9639963, Harvard University Department of Economics.
  2. Robert S. Pindyck, 2009. "Uncertain Outcomes and Climate Change Policy," NBER Working Papers 15259, National Bureau of Economic Research, Inc.
  3. Ottmar Edenhofer & Brigitte Knopf & Terry Barker & Lavinia Baumstark & Elie Bellevrat & Bertrand Chateau & Patrick Criqui & Morna Isaac & Alban Kitous & Socrates Kypreos & Marian Leimbach & Kai Lessma, 2010. "The economics of low stabilization: Model comparison of mitigation strategies and costs," Post-Print halshs-00450290, HAL.
  4. Michael Funke & Michael Paetz, 2007. "Environmental Policy Under Model Uncertainty: A Robust Optimal Control Approach," CESifo Working Paper Series 1938, CESifo Group Munich.
  5. Antony Millner & Simon Dietz & Geoffrey Heal, 2010. "Ambiguity and Climate Policy," NBER Working Papers 16050, National Bureau of Economic Research, Inc.
  6. Zengjing Chen & Larry G. Epstein, 2000. "Ambiguity, risk and asset returns in continuous time," RCER Working Papers 474, University of Rochester - Center for Economic Research (RCER).
  7. Richard Tol, 2002. "Estimates of the Damage Costs of Climate Change. Part 1: Benchmark Estimates," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 21(1), pages 47-73, January.
  8. Giannis Vardas & Anastasios Xepapadeas, 2010. "Model Uncertainty, Ambiguity and the Precautionary Principle: Implications for Biodiversity Management," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 45(3), pages 379-404, March.
  9. Brennan, Michael J. & Schwartz, Eduardo S., 1978. "Finite Difference Methods and Jump Processes Arising in the Pricing of Contingent Claims: A Synthesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(03), pages 461-474, September.
  10. Giuseppe Bertola, 2010. "Options, Inaction, And Uncertainty," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(s1), pages 254-271, 07.
  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. Takao Asano, 2010. "Precautionary Principle and the Optimal Timing of Environmental Policy Under Ambiguity," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 47(2), pages 173-196, October.
  13. Nishimura, Kiyohiko G. & Ozaki, Hiroyuki, 2007. "Irreversible investment and Knightian uncertainty," Journal of Economic Theory, Elsevier, vol. 136(1), pages 668-694, September.
  14. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
  15. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November.
  16. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
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