Inertia Risk: Improving Economic Models of Catastrophes

Anne‐Sophie Crépin and Eric Nævdal

Scandinavian Journal of Economics, 2020, vol. 122, issue 4, 1259-1285

Abstract: We model endogenous catastrophic risk in a new way. We call it “inertia risk”, which accounts for delays between physical variables and the hazard rate – a characteristic often observed in reality. The added realism significantly affects optimal policies relative to the standard model of catastrophic risk. The probability of a catastrophe occurring at some point in time can span the entire interval [0,1], and is not 0 or 1 as is typical in standard models. Inertia risk can also generate path dependences. We illustrate the implications for policy in a simple model of climate change.

Date: 2020
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