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Weitzman meets Nordhaus: Expected utility and catastrophic risk in a stochastic economy-climate model

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  • Masako Ikefuji
  • Roger J. A. Laeven
  • Jan R. Magnus
  • Chris Muris

Abstract

We specify a stochastic economy-climate model, adapting Nordhaus' deterministic economy-climate model by allowing for Weitzman-type stochasticity. We show that, under expected power utility, the model is fragile to heavy-tailed distributional assumptions and we derive necessary and sufficient conditions on the utility function to avoid fragility. We solve our stochastic economy-climate model for two cases with compatible pairs of utility functions and heavy-tailed distributional assumptions. We further develop and implement a procedure to learn the input parameters of our model and show that the model thus specified produces robust optimal policies. The numerical results indicate that higher levels of uncertainty lead to less abatement and consumption, and to more investment.

Suggested Citation

  • Masako Ikefuji & Roger J. A. Laeven & Jan R. Magnus & Chris Muris, 2011. "Weitzman meets Nordhaus: Expected utility and catastrophic risk in a stochastic economy-climate model," ISER Discussion Paper 0825, Institute of Social and Economic Research, Osaka University.
    • Handle: RePEc:dpr:wpaper:0825
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    File URL: https://www.iser.osaka-u.ac.jp/library/dp/2011/DP0825.pdf
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    References listed on IDEAS

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    Cited by:

    1. De Bruin, Kelly & Kiran Krishnamurthy, Chandra, 2021. "Optimal Climate Policy with Fat-tailed Uncertainty: What the Models Can Tell Us," Papers WP697, Economic and Social Research Institute (ESRI).
    2. David Comerford, 2013. "A balance of questions: what can we ask of climate change economics?," Edinburgh School of Economics Discussion Paper Series 216, Edinburgh School of Economics, University of Edinburgh.
    3. Kame Babilla, Thierry, 2014. "Food Price Volatility implications for Trade and Monetary Policy between Nigeria and CEMAC: a Bayesian DSGE model approach," Conference papers 332525, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    4. Masako Ikefuji & Roger Laeven & Jan Magnus & Chris Muris, 2013. "Pareto utility," Theory and Decision, Springer, vol. 75(1), pages 43-57, July.

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