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Yes, we should discount the far-distant future at its lowest possible rate: a resolution of the Weitzman-Gollier puzzle

  • Freeman, Mark C.
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    In this paper the author proves that the Expected Net Future Value (ENFV) criterion can lead a risk neutral social planner to reject projects that increase expected utility. By contrast, the Expected Net Present Value (ENPV) rule correctly identifies the economic value of the project. While the ENFV increases with uncertainty over future interest rates, the expected utility decreases because of the planner's desire to smooth consumption across time. This paper therefore shows that Weitzman (1998) is right and that, within his economy, the far-distant future should be discounted at its lowest possible rate.

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    File URL: http://www.economics-ejournal.org/economics/discussionpapers/2009-42
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    Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2009-42.

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    Date of creation: 2009
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    Handle: RePEc:zbw:ifwedp:200942
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    1. Eric Jacquier & Alex Kane & Alan J. Marcus, 2005. "Optimal Estimation of the Risk Premium for the Long Run and Asset Allocation: A Case of Compounded Estimation Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(1), pages 37-55.
    2. Ekaterini Panopoulou & B. Groom & P. Koundouri & Theologos Pantelidis, 2005. "Discounting the distant future: How much does model selection affect the certainty equivalent rate?," Economics, Finance and Accounting Department Working Paper Series n1480105, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth.
    3. Martin L. Weitzman, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 703-724, September.
    4. Andrew Ang & Jun Liu, 2004. "How to Discount Cashflows with Time-Varying Expected Returns," Journal of Finance, American Finance Association, vol. 59(6), pages 2745-2783, December.
    5. Hepburn, Cameron & Groom, Ben, 2007. "Gamma discounting and expected net future value," Journal of Environmental Economics and Management, Elsevier, vol. 53(1), pages 99-109, January.
    6. Christian Gollier, 2009. "Expected Net Present Value, Expected Net Future Value, and the Ramsey Rule," CESifo Working Paper Series 2643, CESifo Group Munich.
    7. Gollier, Christian, 2009. "Should We Discount the Far-Distant Future at Its Lowest Possible Rate?," Economics Discussion Papers 2009-7, Kiel Institute for the World Economy.
    8. Partha Dasgupta, 2008. "Discounting climate change," Journal of Risk and Uncertainty, Springer, vol. 37(2), pages 141-169, December.
    9. GOLLIER Christian & KOUNDOURI Phoebe & PANTELIDIS Theologos, 2008. "Declining Discount Rates : Economic Justifications and Implications for Long-Run Policy," LERNA Working Papers 08.17.261, LERNA, University of Toulouse.
    10. Gollier, Christian, 2002. "Discounting an uncertain future," Journal of Public Economics, Elsevier, vol. 85(2), pages 149-166, August.
    11. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
    12. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    13. Newell, Richard G. & Pizer, William A., 2004. "Uncertain discount rates in climate policy analysis," Energy Policy, Elsevier, vol. 32(4), pages 519-529, March.
    14. Martin L. Weitzman, 1998. "Gamma Discounting," Harvard Institute of Economic Research Working Papers 1843, Harvard - Institute of Economic Research.
    15. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
    16. Gollier, Christian, 2003. "Maximizing the Expected Net Future Value as an Alternative Strategy to Gamma Discounting," IDEI Working Papers 213, Institut d'Économie Industrielle (IDEI), Toulouse.
    17. Freeman, Mark C., 2009. "The practice of estimating the term structure of discount rates," Global Finance Journal, Elsevier, vol. 19(3), pages 219-234.
    18. Wolfgang Buchholz & Jan Schumacher, 2008. "Discounting the Long-Distant Future: A Simple Explanation for the Weitzman-Gollier-Puzzle," CESifo Working Paper Series 2357, CESifo Group Munich.
    19. William D. Nordhaus, 2007. "A Review of the Stern Review on the Economics of Climate Change," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 686-702, September.
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