Abstract

http://ssrn.com/abstract=1673678
 
 

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Fat Tails, Thin Tails, and Climate Change Policy


Robert S. Pindyck


Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

September 2010

NBER Working Paper No. w16353

Abstract:     
Climate policy is complicated by the considerable compounded uncertainties over the costs and benefits of abatement. We don’t even know the probability distributions for future temperatures and impacts, making cost-benefit analysis based on expected values challenging to say the least. There are good reasons to think that those probability distributions are fat-tailed, which implies that if social welfare is based on the expectation of a CRRA utility function, we should be willing to sacrifice close to 100% of GDP to reduce GHG emissions. I argue that unbounded marginal utility makes little sense, and once we put a bound on marginal utility, this implication of fat tails goes away: Expected marginal utility will be finite even if the distribution for outcomes is fat-tailed. Furthermore, depending on the bound on marginal utility, the index of risk aversion, and the damage function, a thin-tailed distribution can yield a higher expected marginal utility (and thus a greater willingness to pay for abatement) than a fat-tailed one.

Number of Pages in PDF File: 27

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Date posted: September 8, 2010  

Suggested Citation

Pindyck, Robert S., Fat Tails, Thin Tails, and Climate Change Policy (September 2010). NBER Working Paper No. w16353. Available at SSRN: http://ssrn.com/abstract=1673678

Contact Information

Robert S. Pindyck (Contact Author)
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
50 Memorial Drive, E52-450
Cambridge, MA 02142
United States
617-253-6641 (Phone)
617-258-6855 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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