The Social Discount Rate Under Intertemporal Risk Aversion and Ambiguity
40 Pages Posted: 28 Jul 2011
Date Written: December 1, 2008
The social discount rate crucially determines optimal mitigation policies. This paper examines two shortcomings of the recent debate and the models on climate change assessment. First, removing an implicit assumption of (intertemporal) risk neutrality reduces the growth effect in social discounting and significantly amplifies the importance of risk and correlation. Second, debate and models largely overlook the difference in attitude with respect to risk and with respect to non-risk uncertainty. The paper derives the resulting changes of the risk-free and the stochastic social discount rate and points out the importance of even thin tailed uncertainty for climate change evaluation. It discusses combinations of uncertainty and correlation that reduce the social discount rate to pure preference.
Keywords: ambiguity, climate change, cost benefit analysis, discounting, intertemporal substitutability, risk aversion, uncertainty
JEL Classification: D61, D81, D90, H43, Q00, Q54
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