Ambiguous Tipping Points

28 Pages Posted: 2 Oct 2015

See all articles by Derek Lemoine

Derek Lemoine

University of Arizona - Department of Economics

Christian P. Traeger

University of Oslo - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute

Date Written: September 30, 2015

Abstract

We analyze the policy implications of aversion to Knightian uncertainty (ambiguity) about the possibility of tipping points. We demonstrate two channels through which uncertainty aversion affects optimal policy in the general setting. The first channel relates to the policy's effect on the probability of tipping, and the second channel to its differential impact in the pre- and post-tipping regimes. We then extend a recursive dynamic model of climate policy and tipping points to include uncertainty aversion. Numerically, aversion to Knightian uncertainty in the face of an ambiguous tipping point increases the optimal tax on carbon dioxide emissions, but only by a small amount.

Keywords: tipping point, ambiguity, Knightian uncertainty, threshold, regime shift, climate change, hazard, integrated assessment, dynamic programming, social cost of carbon, carbon tax

JEL Classification: Q54, D90, D81, C61, H23

Suggested Citation

Lemoine, Derek and Traeger, Christian P., Ambiguous Tipping Points (September 30, 2015). Available at SSRN: https://ssrn.com/abstract=2667866 or http://dx.doi.org/10.2139/ssrn.2667866

Derek Lemoine

University of Arizona - Department of Economics ( email )

McClelland Hall
Tucson, AZ 85721-0108
United States

HOME PAGE: http://www.dereklemoine.com/

Christian P. Traeger (Contact Author)

University of Oslo - Department of Economics ( email )

Norway

CESifo (Center for Economic Studies and Ifo Institute) - Ifo Institute ( email )

Poschinger Str. 5
Munich, 01069
Germany

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