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Inertia Risk: Improving Economic Models of Catastrophes

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  • Anne‐Sophie Crépin
  • Eric Nævdal

Abstract

We model endogenous catastrophic risk in a new way. We call it “inertia risk”, which accounts for delays between physical variables and the hazard rate – a characteristic often observed in reality. The added realism significantly affects optimal policies relative to the standard model of catastrophic risk. The probability of a catastrophe occurring at some point in time can span the entire interval [0,1], and is not 0 or 1 as is typical in standard models. Inertia risk can also generate path dependences. We illustrate the implications for policy in a simple model of climate change.

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  • Anne‐Sophie Crépin & Eric Nævdal, 2020. "Inertia Risk: Improving Economic Models of Catastrophes," Scandinavian Journal of Economics, Wiley Blackwell, vol. 122(4), pages 1259-1285, October.
    • Handle: RePEc:bla:scandj:v:122:y:2020:i:4:p:1259-1285
    DOI: 10.1111/sjoe.12381
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