Cost Risk Analysisː How Robust Is It in View of Weitzman's Dismal Theorem and Undetermined Risk Functions?

Hermann Held

No 55, WiSo-HH Working Paper Series from University of Hamburg, Faculty of Business, Economics and Social Sciences, WISO Research Laboratory

Abstract: Cost risk analysis (CRA) is currently emerging as a noticed decision-analytic framework within the field of climate economics. It combines the expected utility-based structure of cost benefit analysis (CBA) with the target-based approach of cost effectiveness analysis (CEA). As such, it offers a promising candidate for those decision-makers who would like to express their precautionary attitude in view of deeply uncertain global warming impacts through a temperature target, yet who would like to avoid the dynamic inconsistencies of CEA. Here we ask the question whether CRA is potentially subject to the 'dismal theorem' after Weitzman (2009b) like CBA is. We find that in fact, structurally similar issues may arise which, however, can be ameliorated through options specific to CRA. As CRA is not a well-established concept yet, for the convenience of the reader we start by reviewing both its rationale and key results derived from it. This will provide the conceptual basis of justification for CRA-specific solutions of dismal theorem-type effects. The two alternative solutions we offer are as follows. (i) Capping marginal risk at some maximum temperature value beyond which a decision maker caring about the precautionary principle might not show any interest; (ii) sticking to the most conservative risk function of kink-linear type, still in-line with the axiomatic of CRA, thereby avoiding singularities in expected marginal risk.

Keywords: dismal theorem; climate targets; fat tails; cost risk analysis; decision under uncertainty; mitigation; precautionary principle (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:uhhwps:55

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