Risk and Return in Environmental Economics
Name
2012-010.pdf
Description
main article
Size
842.36 KB
Format
Adobe PDF
Checksum (MD5)
484be433b657277f1a593085f80f3fce
Author(s)
Pindyck, Robert S.
Date Issued
July 2012
Publisher
MIT CEEPR
Citation
CEEPR-WP-2012-010
Series/Report no.
CEEPR Working Papers;2012-010
Abstract
I examine the risk/return tradeoff for environmental investments, and its implications for policy choice. Consider a policy to reduce carbon emissions. To what extent does the value of such a policy depend on the expected future damages from global warming versus uncertainty over those damages, i.e., on the expected benefits from the policy versus their riskiness? And to what extent should the policy objective be a reduction in the expected temperature increase versus a reduction in risk? Using a simple model of a stock externality (e.g., temperature) that evolves stochastically, I examine the “willingness to pay” (WTP) for alternative policies that would reduce the expected damages under “business as usual” (BAU) versus the variance of those damages. I also show how one can compute “iso-WTP” curves (social indifference curves) for combinations of risk and expected returns as policy objectives. Given cost estimates for reducing risk and increasing expected returns, one can compute the optimal risk-return mix for a policy, and the policy’s social surplus. I illustrate these results by calibrating the model to data for global warming.
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