Climate Policy Under Fat-Tailed Risk: An Application of Dice

I.C. Hwang, F. Reynes, R.S.J. Tol

Research output: Contribution to JournalArticleAcademicpeer-review

Abstract

Uncertainty plays a significant role in evaluating climate policy, and fat-tailed uncertainty may dominate policy advice. Should we make our utmost effort to prevent the arbitrarily large impacts of climate change under deep uncertainty? In order to answer to this question, we propose a new way of investigating the impact of (fat-tailed) uncertainty on optimal climate policy: the curvature of the optimal carbon tax against the uncertainty. We find that the optimal carbon tax increases as the uncertainty about climate sensitivity increases, but it does not accelerate as implied by Weitzman's Dismal Theorem. We find the same result in a wide variety of sensitivity analyses. These results emphasize the importance of balancing the costs of climate change against its benefits, also under deep uncertainty. © 2013 Springer Science+Business Media Dordrecht.
LanguageEnglish
Pages415-436
JournalEnvironmental and Resource Economics
Volume56
Issue number3
DOIs
Publication statusPublished - 2013

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pollution tax
environmental policy
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Climate policy
Uncertainty
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Cite this

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Climate Policy Under Fat-Tailed Risk: An Application of Dice. / Hwang, I.C.; Reynes, F.; Tol, R.S.J.

In: Environmental and Resource Economics, Vol. 56, No. 3, 2013, p. 415-436.

Research output: Contribution to JournalArticleAcademicpeer-review

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AU - Reynes, F.

AU - Tol, R.S.J.

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AB - Uncertainty plays a significant role in evaluating climate policy, and fat-tailed uncertainty may dominate policy advice. Should we make our utmost effort to prevent the arbitrarily large impacts of climate change under deep uncertainty? In order to answer to this question, we propose a new way of investigating the impact of (fat-tailed) uncertainty on optimal climate policy: the curvature of the optimal carbon tax against the uncertainty. We find that the optimal carbon tax increases as the uncertainty about climate sensitivity increases, but it does not accelerate as implied by Weitzman's Dismal Theorem. We find the same result in a wide variety of sensitivity analyses. These results emphasize the importance of balancing the costs of climate change against its benefits, also under deep uncertainty. © 2013 Springer Science+Business Media Dordrecht.

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