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Welfare Costs of Long-Run Temperature Shifts

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  • Ravi Bansal
  • Marcelo Ochoa

Abstract

This article makes a contribution towards understanding the impact of temperature fluctuations on the economy and financial markets. We present a long-run risks model with temperature related natural disasters. The model simultaneously matches observed temperature and consumption growth dynamics, and key features of financial markets data. We use this model to evaluate the role of temperature in determining asset prices, and to compute utility-based welfare costs as well as dollar costs of insuring against temperature fluctuations. We find that the temperature related utility-costs are about 0.78% of consumption, and the total dollar costs of completely insuring against temperature variation are 2.46% of world GDP. If we allow for temperature-triggered natural disasters to impact growth, insuring against temperature variation raise to 5.47% of world GDP. We show that the same features, long-run risks and recursive-preferences, that account for the risk-free rate and the equity premium puzzles also imply that temperature-related economic costs are important. Our model implies that a rise in global temperature lowers equity valuations and raises risk premiums.

Suggested Citation

  • Ravi Bansal & Marcelo Ochoa, 2011. "Welfare Costs of Long-Run Temperature Shifts," NBER Working Papers 17574, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17574
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Hjort, Ingrid, 2016. "Potential Climate Risks in Financial Markets: A Literature Overview," Memorandum 01/2016, Oslo University, Department of Economics.
    2. repec:eee:dyncon:v:82:y:2017:i:c:p:331-355 is not listed on IDEAS
    3. Armon Rezai & Frederick Van der Ploeg, 2016. "Intergenerational Inequality Aversion, Growth, and the Role of Damages: Occam's Rule for the Global Carbon Tax," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 3(2), pages 493-522.
    4. Riccardo Colacito & Bridget Hoffmann & Toan Phan, 2016. "Temperature and Growth: A Panel Analysis of the United States," IDB Publications (Working Papers) 7654, Inter-American Development Bank.
    5. Yongyang Cai & Kenneth L. Judd & Thomas S. Lontzek, 2015. "The Social Cost of Carbon with Economic and Climate Risks," Papers 1504.06909, arXiv.org, revised Apr 2015.
    6. Robert S. Pindyck, 2014. "Risk and Return in the Design of Environmental Policy," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 1(3), pages 395-418.
    7. Christoph Hambel & Holger Kraft & Eduardo Schwartz, 2015. "Optimal Carbon Abatement in a Stochastic Equilibrium Model with Climate Change," NBER Working Papers 21044, National Bureau of Economic Research, Inc.
    8. Pindyck, Robert S., 2012. "Uncertain outcomes and climate change policy," Journal of Environmental Economics and Management, Elsevier, vol. 63(3), pages 289-303.
    9. Hambel, Christoph & Kraft, Holger & Schwartz, Eduardo S., 2015. "Optimal carbon abatement in a stochastic equilibrium model with climate change," SAFE Working Paper Series 92, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    10. Karp, Larry & Rezai, Armon, 2017. "Asset prices and climate policy," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt6fx579fp, Department of Agricultural & Resource Economics, UC Berkeley.
    11. Robert S. Pindyck, 2013. "The Climate Policy Dilemma," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 7(2), pages 219-237, July.
    12. Robert S. Pindyck, 2012. "Risk and Return in Environmental Economics," NBER Working Papers 18262, National Bureau of Economic Research, Inc.
    13. repec:eee:macchp:v2-1893 is not listed on IDEAS
    14. Donadelli, M. & Jüppner, M. & Riedel, M. & Schlag, C., 2017. "Temperature shocks and welfare costs," Journal of Economic Dynamics and Control, Elsevier, vol. 82(C), pages 331-355.
    15. Rick Van der Ploeg & Armon Rezai, 2015. "Intergenerational Inequality Aversion, Growth and the Role of Damages: Occam's rule for the global tax," Economics Series Working Papers OxCarre Research Paper 15, University of Oxford, Department of Economics.
    16. Riccardo Colacito & Bridget Hoffmann & Toan Phan, 2016. "Temperature and Growth: A Panel Analysis of the United States," IDB Publications (Working Papers) 94298, Inter-American Development Bank.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • G0 - Financial Economics - - General
    • Q0 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General

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