Discounting Under Uncertainty: Disentangling the Weitzman and the Gollier Effect

Abstract

The uncertainty of future economic development affects the term structure of discount rates and, thus, the intertemporal weights that are to be used in cost benefit analysis. The U.K. and France have recently adopted a falling term structure to incorporate uncertainty and the U.S. is considering a similar step. A series of publications discusses the following concern: A seemingly analogous argument used to justify falling discount rates can also justify increasing discount rates. We show that increasing and decreasing discount rates mean different things, can coexist, are created by different channels through which risk affects evaluation, and have the same qualitative effect of making long-term payoffs more attractive.

Keywords: benefit cost analysis, discounting, term structure, uncertainty, Weitzman-Gollier puzzle

JEL Classification: D61, D81, H43, Q54