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Optimal Discount Rates for Investments in Mitigation and Adaptation

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  • Rob Aalbers

    (CPB Netherlands Bureau for Economic Policy Analysis)

Abstract

This paper develops a theory of asset pricing in which discount rates for investments in all assets, including adaptation and mitigation, are endogenously determined. Exploiting the characteristics of adaptation and mitigation in terms of climatic risk, I show that adaptation requires a lower discount rate, whereas mitigation does not. Inspection of the Ramsey rule reveals that the social discount rate equals the social rate of return on optimally-invested aggregate wealth minus the risk premium on that wealth. This risk premium compensates investors for bearing market risk and the risk of unfavorable changes in the economy resulting from climate change. This paper functions as an update of Discussion Paper 126.

Suggested Citation

  • Rob Aalbers, 2013. "Optimal Discount Rates for Investments in Mitigation and Adaptation," CPB Discussion Paper 257, CPB Netherlands Bureau for Economic Policy Analysis.
    • Handle: RePEc:cpb:discus:257
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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