The risk-adjusted carbon price
Tinbergen Institute Discussion Paper 2021-046/VI
91 Pages Posted: 25 May 2021
Date Written: April 30, 2021
The social cost of carbon is the expected present value of damages from emitting one ton of carbon today. We use perturbation theory to derive an approximate tractable expression for this cost adjusted for climatic and economic risk. We allow for different aversion to risk and intertemporal fluctuations, skewness and dynamics in the risk distributions of climate sensitivity and the damage ratio, and correlated shocks. We identify prudence, insurance, and exposure effects, reproduce earlier analytical results, and offer analytical insights into numerical results on the effects of economic and damage ratio uncertainty and convex damages on the optimal carbon price.
Keywords: precaution, insurance, exposure, economic and climatic and damage uncertainties, skewness, mean reversion, correlated risks, risk aversion, intergenerational inequality aversion, convex damages
JEL Classification: H21, Q51, Q54
Suggested Citation: Suggested Citation