Risk and Return in Environmental Economics
Author(s)Pindyck, Robert S.
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Risk and Return in the Design of Environmental Policy
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I examine risk/return trade-offs for environmental investments and their implications for policy choice. Consider a policy to reduce carbon emissions. 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 that evolves stochastically, I examine the “willingness to pay” (WTP) for alternative policies that would reduce expected damages versus the variance of those damages. I compute “iso-WTP” curves (social indifference curves) for combinations of risk and expected return 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.
DepartmentSloan School of Management
Journal of the Association of Environmental and Resource Economists
University of Chicago Press
Pindyck, Robert S. “Risk and Return in the Design of Environmental Policy.” Journal of the Association of Environmental and Resource Economists 1, no. 3 (September 2014): 395–418.