Fixing Our Public Discounting Systems

Frédéric Cherbonnier and Christian Gollier ()
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Frédéric Cherbonnier: Toulouse School of Economics, Toulouse, France
Christian Gollier: University of Toulouse Capitole, Toulouse, France

Annual Review of Financial Economics, 2023, vol. 15, issue 1, 147-164

Abstract: Most Western countries use a single discount rate to evaluate public investments and policies. This ignores the differential cost of risk, in a world where most risk markets exhibit surprisingly large prices of risk. The current discounting guidelines generate a misallocation of capital that entails a large welfare cost. We claim that the well-established asset pricing literature provides a strong normative justification in favor of risk-adjusting discount rates. More specifically, project-specific discount rates should be increasing in the income elasticity of the project's net benefit. This will favor projects whose net benefit materializes preferentially in low-income states, thereby recognizing their insurance benefit ex ante. The intuition is simple, the welfare benefit of the reform is large, and the methodology only requires evaluators to estimate an income elasticity on top of what is required in the current approach. It is time to fix our public discounting systems.

Keywords: discounting; risk adjustment; carbon pricing; cost-benefit analysis (search for similar items in EconPapers)
JEL-codes: G12 H43 Q54 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1146/annurev-financial-102921-111749

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