Risk aversion, time preference, and the social cost of carbon

Abstract

The Stern Review reported a social cost of carbon of over $300/tC, calling for ambitious climate policy. We here conduct a systematic sensitivity analysis of this result on two crucial parameters: the rate of pure time preference, and the rate of risk aversion. We show that the social cost of carbon lies anywhere in between 0 and $120 000/tC. However, if we restrict these two parameters to matching observed behaviour, an expected social cost of carbon of $60/tC results. If we correct this estimate for income differences across the world, the social cost of carbon rises to over $200/tC. Keywords: economics of climate change, social cost of carbon, risk aversion, rate of pure time preference S Supplementary data are available from stacks.iop.org/ERL/4/024002

The uncertainty about the social cost of carbon: A decomposition analysis using fund

“…For lower pure rates of time preference, the social cost of carbon rises (Guo et al 2006). For higher rates of risk aversion, the social cost of carbon falls, because its effect on the discount rate dominates its effect on the certainty equivalent (Anthoff et al 2009b;Anthoff et al 2009c). Table 2 shows the regional results for ρ=1% and η=1.5.…”

“…The effect of changes in the rate of risk aversion is harder to interpret, because it affects the discount rate, the equity weights, and, of course, the certainty equivalent (Anthoff et al 2009b;Anthoff et al 2009c). As the rate of risk aversion increases, uncertainty becomes more important, the impacts on developing countries get a higher weight, and future counts for less.…”

Siblings, Not Triplets: Social Preferences for Risk, Inequality and Time in Discounting Climate Change

“…Yet while δ is important to the economics of climate change, so too are η and g. As Anthoff, Tol and Yohe (2008), and Stern (2007) demonstrate, the costs and benefits of mitigating climate change are very sensitive to the specific parameter choice for η. Unfortunately, the debate following the Stern Review has shown that there is little agreement on precisely what value η should take.…”

“…In addition, the outcome of numerical modelling of climate policy is very sensitive to this parameter (Anthoff, Tol and Yohe, 2008;Stern, 2007). η has often been set to unity (Fankhauser et al, 1997;Nordhaus and Boyer, 2000;Stern, 2007;Tol, 1997), which gives the particularly tractable case of equation (2) where utility is the natural logarithm of consumption.…”

“…The relationship between η and the optimal rate of greenhouse gas emissions control is a priori unclear, because increasing η has three possibly divergent effects (Anthoff, Tol and Yohe, 2008;Dietz et al, 2007). In the context of estimates of climate-change damage, higher aversion to intertemporal inequality might well lower present-value estimates of long-run damage, because it increases the discount rate as long as expected future growth rates are positive.…”