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

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

*Corresponding author for this work

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
Pages (from-to)110-129
Number of pages20
JournalJournal of Econometrics
Volume214
Issue number1
DOIs
Publication statusPublished - 2020

Keywords

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

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