Expected utility and catastrophic risk in a stochastic economy–climate model

Masako Ikefuji, Roger J.A. Laeven, Jan R. Magnus, Chris Muris

Research output: Contribution to JournalArticleAcademicpeer-review

Abstract

We analyze a stochastic dynamic finite-horizon economic model with climate change, in which the social planner faces uncertainty about future climate change and its economic damages. Our model (SDICE*) incorporates, possibly heavy-tailed, stochasticity in Nordhaus’ deterministic DICE model. We develop a regression-based numerical method for solving a general class of dynamic finite-horizon economy–climate models with potentially heavy-tailed uncertainty and general utility functions. We then apply this method to SDICE* and examine the effects of light- and heavy-tailed uncertainty. The results indicate that the effects can be substantial, depending on the nature and extent of the uncertainty and the social planner's preferences.

Original languageEnglish
JournalJournal of Econometrics
DOIs
Publication statusAccepted/In press - 2019

Fingerprint

Catastrophic risk
Stochastic model
Expected utility
Uncertainty
Climate change
Finite horizon
Stochastic dynamics
Economics
Numerical methods
Social preferences
Utility function
Damage

Keywords

  • Economy–climate models
  • Economy–climate policy
  • Expected utility
  • Heavy tails
  • Uncertainty

Cite this

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title = "Expected utility and catastrophic risk in a stochastic economy–climate model",
abstract = "We analyze a stochastic dynamic finite-horizon economic model with climate change, in which the social planner faces uncertainty about future climate change and its economic damages. Our model (SDICE*) incorporates, possibly heavy-tailed, stochasticity in Nordhaus’ deterministic DICE model. We develop a regression-based numerical method for solving a general class of dynamic finite-horizon economy–climate models with potentially heavy-tailed uncertainty and general utility functions. We then apply this method to SDICE* and examine the effects of light- and heavy-tailed uncertainty. The results indicate that the effects can be substantial, depending on the nature and extent of the uncertainty and the social planner's preferences.",
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Expected utility and catastrophic risk in a stochastic economy–climate model. / Ikefuji, Masako; Laeven, Roger J.A.; Magnus, Jan R.; Muris, Chris.

In: Journal of Econometrics, 2019.

Research output: Contribution to JournalArticleAcademicpeer-review

TY - JOUR

T1 - Expected utility and catastrophic risk in a stochastic economy–climate model

AU - Ikefuji, Masako

AU - Laeven, Roger J.A.

AU - Magnus, Jan R.

AU - Muris, Chris

PY - 2019

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N2 - We analyze a stochastic dynamic finite-horizon economic model with climate change, in which the social planner faces uncertainty about future climate change and its economic damages. Our model (SDICE*) incorporates, possibly heavy-tailed, stochasticity in Nordhaus’ deterministic DICE model. We develop a regression-based numerical method for solving a general class of dynamic finite-horizon economy–climate models with potentially heavy-tailed uncertainty and general utility functions. We then apply this method to SDICE* and examine the effects of light- and heavy-tailed uncertainty. The results indicate that the effects can be substantial, depending on the nature and extent of the uncertainty and the social planner's preferences.

AB - We analyze a stochastic dynamic finite-horizon economic model with climate change, in which the social planner faces uncertainty about future climate change and its economic damages. Our model (SDICE*) incorporates, possibly heavy-tailed, stochasticity in Nordhaus’ deterministic DICE model. We develop a regression-based numerical method for solving a general class of dynamic finite-horizon economy–climate models with potentially heavy-tailed uncertainty and general utility functions. We then apply this method to SDICE* and examine the effects of light- and heavy-tailed uncertainty. The results indicate that the effects can be substantial, depending on the nature and extent of the uncertainty and the social planner's preferences.

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KW - Economy–climate policy

KW - Expected utility

KW - Heavy tails

KW - Uncertainty

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