Discounting the Distant Future: How Much Do Uncertain Rates Increase Valuations?

Resources For the Future Discussion Paper No. 00-45

49 Pages Posted: 10 Feb 2003

See all articles by Richard G. Newell

Richard G. Newell

Duke University - Nicholas School of Environment; National Bureau of Economic Research (NBER); Resources for the Future

William A. Pizer

Duke University

Multiple version iconThere are 2 versions of this paper

Date Written: May 2001

Abstract

Costs and benefits in the distant future, such as those associated with global warming, long-lived infrastructure, hazardous and radioactive waste, and biodiversity often have little value today when measured with conventional discount rates. We demonstrate that when the future path of this conventional rate is uncertain and persistent (i.e., highly correlated over time), the distant future should be discounted at lower rates than suggested by the current rate. We then use two centuries of data on U.S. interest rates to quantify this effect. Using both random walk and mean-reverting models, we compute the certainty-equivalent rate that is, the single discount rate that summarizes the effect of uncertainty and measures the appropriate forward rate of discount in the future. Using the random walk model, which we consider more compelling, we find that the certainty-equivalent rate falls from 4%, to 2% after 100 years, 1% after 200 years, and 0.5% after 300 years. If we use these rates to value consequences at horizons of 400 years, the discounted value increases by a factor of over 40,000 relative to conventional discounting. Applying the random walk model to the consequences of climate change, we find that inclusion of discount rate uncertainty almost doubles the expected present value of mitigation benefits.

Keywords: Discounting, uncertainty, interest rate forecasting, climate policy,intergenerational equity

JEL Classification: D90, E47, C53, H43, Q28

Suggested Citation

Newell, Richard G. and Pizer, William A., Discounting the Distant Future: How Much Do Uncertain Rates Increase Valuations? (May 2001). Resources For the Future Discussion Paper No. 00-45. Available at SSRN: https://ssrn.com/abstract=366281 or http://dx.doi.org/10.2139/ssrn.366281

Richard G. Newell (Contact Author)

Duke University - Nicholas School of Environment ( email )

Box 90228
Durham, NC 27708-0328
United States
919-681-8865 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Resources for the Future ( email )

1616 P Street, NW
Washington, DC 20036
United States

William A. Pizer

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

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