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Optimal Expectations and the Welfare Cost of Climate Variability

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  • Alem, Yonas
  • Colmer, Jonathan

Abstract

Uncertainty about the future is an important determinant of well-being, especially in developing countries where financial markets and other market failures result in ineffective insurance mechanisms. However, separating the effects of future uncertainty from realised events, and then measuring the impact of uncertainty on utility, presents a number of empirical challenges. This paper aims to address these issues and provides supporting evidence to show that increased climate variability (a proxy for future income uncertainty) reduces farmers' subjective well-being, consistent with the theory of optimal expectations (Brunnermeier & Parker, 2005 AER), using panel data from rural Ethiopia and a new data set containing daily atmospheric parameters. The magnitude of our result indicates that a one standard deviation (7%) increase in climate variability has an equivalent effect on life satisfaction to a two standard deviation (1-2%) decrease in consumption. This effect is one of the largest determinants of life satisfaction in rural Ethiopia.

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  • Alem, Yonas & Colmer, Jonathan, 2014. "Optimal Expectations and the Welfare Cost of Climate Variability," RFF Working Paper Series dp-14-03-efd, Resources for the Future.
  • Handle: RePEc:rff:dpaper:dp-14-03-efd
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    2. Jonathan Colmer, 2013. "Climate Variability, Child Labour and Schooling: Evidence on the Intensive and Extensive Margin," GRI Working Papers 132, Grantham Research Institute on Climate Change and the Environment.
    3. Alan Piper, 2014. "Zukunftsangst! Fear of (and Hope for) the Future and Its Impact on Life Satisfaction," SOEPpapers on Multidisciplinary Panel Data Research 706, DIW Berlin, The German Socio-Economic Panel (SOEP).
    4. Alem, Yonas, 2013. "Relative Standing and Life-Satisfaction: Does Unobserved Heterogeneity Matter?," Working Papers in Economics 579, University of Gothenburg, Department of Economics.
    5. Alem, Yonas, 2014. "Life-Satisfaction in Urban Ethiopia: The Role of Relative Poverty and Unobserved Heterogeneity," RFF Working Paper Series dp-14-04-efd, Resources for the Future.
    6. Zanhouo, Abdoul Karim & Acma, Bulent, 2021. "Impact of climate change on households welfare in Burkina Faso. Welfare decomposition analysis," Conference papers 333260, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    7. Akinwumi Sharimakin, 2023. "Microfinance bank in Nigeria: operating environment, sustainability, and welfare impact," SN Business & Economics, Springer, vol. 3(10), pages 1-27, October.

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    • C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions; Probabilities
    • D60 - Microeconomics - - Welfare Economics - - - General
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being

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