Welfare Costs of Long-Run Temperature Shifts

44 Pages Posted: 4 Nov 2011

See all articles by Ravi Bansal

Ravi Bansal

Duke University and NBER

Juan Marcelo Ochoa

affiliation not provided to SSRN

Date Written: November 2011

Abstract

This article makes a contribution towards understanding the impact of temperature fluctuations on the economy and financial markets. We present a long-run risks model with temperature related natural disasters. The model simultaneously matches observed temperature and consumption growth dynamics, and key features of financial markets data. We use this model to evaluate the role of temperature in determining asset prices, and to compute utility-based welfare costs as well as dollar costs of insuring against temperature fluctuations. We find that the temperature related utility-costs are about 0.78% of consumption, and the total dollar costs of completely insuring against temperature variation are 2.46% of world GDP. If we allow for temperature-triggered natural disasters to impact growth, insuring against temperature variation raise to 5.47% of world GDP. We show that the same features, long-run risks and recursive-preferences, that account for the risk-free rate and the equity premium puzzles also imply that temperature-related economic costs are important. Our model implies thata rise in global temperature lowers equity valuations and raises risk premiums.

Suggested Citation

Bansal, Ravi and Ochoa, Juan Marcelo, Welfare Costs of Long-Run Temperature Shifts (November 2011). NBER Working Paper No. w17574, Available at SSRN: https://ssrn.com/abstract=1954500

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Juan Marcelo Ochoa

affiliation not provided to SSRN ( email )

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