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Evaluation of long-dated assets : The role of parameter uncertainty

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  • Gollier, Christian

Abstract

Because of the uncertainty about how to model the growth process of our economy, there is still much confusion about which discount rates should be used to evaluate actions having long-lasting impacts, as in the contexts of climate change, social security reforms or large public infrastructures for example. We characterize efficient discount rates when the growth of log consumption follows a random walk with uncertain parameters. We examine different models in which the parametric uncertainty affects the trend and the volatility of growth, or the frequency of catastrophes. This uncertainty implies that the term structures of the risk free discount rate and of the aggregate risk premium are respectively decreasing and increasing. It also implies that the discount rate is increasing with maturity if the beta of the investment is larger than half of relative risk aversion. Another important consequence of parametric uncertainty is that the risk premium is not proportional to the beta of the investment. Finally, we apply our findings to the evaluation of climate change policy. We argue in particular that the beta of actions to mitigate climate change is relatively large, so that the term structure of the associated discount rates should be increasing.

Suggested Citation

  • Gollier, Christian, 2012. "Evaluation of long-dated assets : The role of parameter uncertainty," TSE Working Papers 12-361, Toulouse School of Economics (TSE), revised Sep 2015.
  • Handle: RePEc:tse:wpaper:26574
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    Cited by:

    1. Gollier, Christian, 2012. "A theory of rational short-termism with uncertain betas," LERNA Working Papers 12.14.371, LERNA, University of Toulouse.
    2. Freeman, Mark C. & Wagner, Gernot & Zeckhauser, Richard J., 2015. "Climate Sensitivity Uncertainty: When Is Good News Bad?," Working Paper Series rwp15-002, Harvard University, John F. Kennedy School of Government.
    3. Giglio, Stefano & Maggiori, Matteo & Stroebel, Johannes, 2014. "Very long-run discount rates," Globalization and Monetary Policy Institute Working Paper 182, Federal Reserve Bank of Dallas.
    4. Gollier, Christian, 2012. "Asset pricing with uncertain betas: A long-term perspective," TSE Working Papers 12-354, Toulouse School of Economics (TSE).
    5. Richard Kihlstrom & Christian Gollier, 2016. "Early resolution of uncertainty and asset prices," 2016 Meeting Papers 475, Society for Economic Dynamics.
    6. Corneo, Giacomo, 2015. "Volkswirtschaftliche Bewertung öffentlicher Investitionen," Discussion Papers 2015/12, Free University Berlin, School of Business & Economics.
    7. Rob Aalbers, 2013. "Optimal Discount Rates for Investments in Mitigation and Adaptation," CPB Discussion Paper 257, CPB Netherlands Bureau for Economic Policy Analysis.

    More about this item

    Keywords

    asset prices; term structure; risk premium; decreasing discount rates; parametric uncertainty; CO2 beta; rare events; macroeconomic catastrophes;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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