Concerns for Long-Run Risks and Natural Resource Policy

Johnson Kakeu

Environmental & Resource Economics, 2023, vol. 84, issue 4, No 6, 1093 pages

Abstract: Abstract The legislature in many countries requires that short-run risk and long-run risk be considered in making natural resource policy. In this paper, we explore this issue by analyzing how natural resource conservation policy should optimally respond to long-run risks in a resource management framework where the social evaluator has (Duffie and Epstein in Econometrica 60:353–394, 1992; Schroder and Skiadas in J Econ Theory 89:68–126, 1999) continuous-time stochastic recursive preferences. The response of resource conservation policy to long-run risks is reflected into a matrix whose coefficients measure precaution toward short-run risk, long-run risk and covariance risk. Attitudes toward the temporal resolution of risk underly concerns for long-run risks as well as the response of resource conservation policy to future uncertainty. We formally compare the responses of natural resource policy to long-run risks under recursive utility and under time-additive expected utility. A stronger preference for early resolution of uncertainty can prompt a more conservative resource policy as a response to long-run risks. In the very particular case where the social evaluator preferences are represented by a standard time-additive expected utility, long-run risks are not factored in resource conservation policy decisions. Our work also contributes to the so-called Hotelling Puzzle by formally showing that the fundamental Hotelling’s homogeneous resource depletion problem (one without extraction costs, without new discoveries, and without technical progress) can lead to a decreasing shadow price when attitudes toward the temporal resolution of risk are accounted for.

Keywords: Natural resource policy; Long-run risk; Short-run risk; Continuous-time stochastic recursive utility; Temporal resolution of uncertainty; Hotelling Puzzle (search for similar items in EconPapers)
JEL-codes: D81 O44 Q2 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s10640-022-00748-0

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