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Preventing Controversial Catastrophes

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  • Steven D. Baker
  • Burton Hollifield
  • Emilio Osambela

Abstract

In a market-based democracy, different constituencies will disagree regarding the likelihood and severity of potential economic disasters. Costly public policy initiatives to reduce or eliminate disasters will be assessed relative to alternatives provided by financial markets, where constituencies can trade insurance optimally given the different risks they perceive. In a general equilibrium production economy where two agents disagree about the likelihood of disasters, we define consensus willingness to pay (WTP): the maximum consumption tax rate that both agents would accept to fund a disaster reducing policy. We investigate the level and dynamics of WTP. For example, we show that a policy to eliminate the most severe disasters would be supported at higher cost immediately after a disaster occurs. Policies that eliminate speculative trade entirely typically have higher WTP after a boom. Policies that target uncontroversial tail risk generally have higher WTP than policies that would eliminate sources of disagreement.

Suggested Citation

  • Steven D. Baker & Burton Hollifield & Emilio Osambela, "undated". "Preventing Controversial Catastrophes," GSIA Working Papers 2015-E35, Carnegie Mellon University, Tepper School of Business.
    • Handle: RePEc:cmu:gsiawp:-1921737996
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    References listed on IDEAS

    as
    1. Robert J. Barro & Jose F. Ursua, 2008. "Consumption Disasters in the Twentieth Century," American Economic Review, American Economic Association, vol. 98(2), pages 58-63, May.
    2. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    3. Robert J. Barro, 2009. "Rare Disasters, Asset Prices, and Welfare Costs," American Economic Review, American Economic Association, vol. 99(1), pages 243-264, March.
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