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Random Error and Simulation Models With an Unobserved Dependent Variable as applied to the Benefits and Costs of the Clean Air Act

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Abstract

Most empirical simulation models used in benefit-cost or risk analysis investigate uncertainty based on variability in parameters and conditioning factors. A pure random error term is frequently omitted. Ex-ante benefit-cost analyses create a particular problem because there are not historically observed values of the dependent variable, such as net present value. An estimator for the error variance is developed based on analysis of variance measures and R-squared. When applied to a model of the net benefits of the Clean Air Act, the probability that the net present value is negative increases from .2 to 4.5 percent.

Suggested Citation

  • Scott Farrow, "undated". "Random Error and Simulation Models With an Unobserved Dependent Variable as applied to the Benefits and Costs of the Clean Air Act," UMBC Economics Department Working Papers 09-103, UMBC Department of Economics, revised 26 Jan 2008.
  • Handle: RePEc:umb:econwp:09103
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    File URL: http://www.umbc.edu/economics/wpapers/wp_09_102_CWISFarrow.pdf
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    References listed on IDEAS

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    1. John A. List & Robert P. Berrens & Alok K. Bohara & Joe Kerkvliet, 2004. "Examining the Role of Social Isolation on Stated Preferences," American Economic Review, American Economic Association, vol. 94(3), pages 741-752, June.
    2. repec:reg:rpubli:98 is not listed on IDEAS
    3. Arrow, Kenneth J. & Cropper, Maureen L. & Eads, George C. & Hahn, Robert W. & Lave, Lester B. & Noll, Roger G. & Portney, Paul R. & Russell, Milson & Schmalensee, Richard & Smith, V. Kerry & Stavins, , 1997. "Is there a role for benefit-cost analysis in environmental, health, and safety regulation?," Environment and Development Economics, Cambridge University Press, vol. 2(02), pages 195-221, May.
    4. Robert W. Hahn & Richard L. Schmalensee & Roger Noll & Robert Stavins & Lester B. Lave & George C. Eads & Milton Russell & V. Kerry Smith & Maureen L. Cropper & Paul R. Portney & Kenneth J. Arrow, 1996. "Benefit-Cost Analysis in Environmental, Health, and Safety Regulation," Books, American Enterprise Institute, number 51790.
    5. Spash, Clive L., 2007. "Deliberative monetary valuation (DMV): Issues in combining economic and political processes to value environmental change," Ecological Economics, Elsevier, vol. 63(4), pages 690-699, September.
    6. Robert W. Hahn & Patrick M. Dudley, 2007. "How Well Does the U.S. Government Do Benefit-Cost Analysis?," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 1(2), pages 192-211, Summer.
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    More about this item

    Keywords

    Simulation; random error; benefit-cost;

    JEL classification:

    • H4 - Public Economics - - Publicly Provided Goods
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling

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