Why uncertainty matters - discounting under intertemporal risk aversion and ambiguity

Christian Traeger

Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series from Department of Agricultural & Resource Economics, UC Berkeley

Abstract: Uncertainty has an almost negligible impact on project value in the standardeconomic model. I show that a comprehensive evaluation of uncertainty and uncertainty attitude changes this picture fundamentally. The illustration of this result relies on the discount rate, which is the crucial determinant in balancing immediate costs againstfuture benefits, and the single most important determinant of optimal mitigation policies in the integrated assessment of climate change. First, the paper removes an implicit assumption of (intertemporal or intrinsic) risk neutrality from the standard economic model. Second, the paper introduces aversion to non-risk uncertainty (ambiguity). Ishow a close formal similarity between the model of intertemporal risk aversion, which is a reformulation of the widespread Epstein-Zin-Weil model, and a recent model of smooth ambiguity aversion. I merge the models, achieving a threefold disentanglement between, risk aversion, ambiguity aversion, and the propensity to smooth consumptionover time.

Keywords: ambiguity; climate change; cost benefit analysis; discounting; intertemporal substitutability; risk aversion; uncertainty; Social and Behavioral Sciences; Life Sciences (search for similar items in EconPapers)
Date: 2012-05-11
New Economics Papers: this item is included in nep-ene, nep-env, nep-mic, nep-ppm and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Journal Article: Why uncertainty matters: discounting under intertemporal risk aversion and ambiguity (2014)
Working Paper: Why Uncertainty Matters - Discounting under Intertemporal Risk Aversion and Ambiguity (2012)
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