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Wealth Management and Uncertain Tipping Points

Steinar Strøm and Jon Vislie

No 7487, CESifo Working Paper Series from CESifo Group Munich

Abstract: We analyze optimal wealth management, within a global setting, where accumulation of GHGs caused by extraction of fossil resources affects the probability distribution for hitting a threshold or tipping point, indicating a climate change. We derive an optimal strategy for overall wealth management, within a Ramsey-Hotelling-framework. We have two assets; one being reproducible (reversible capital equipment) and another being non-reproducible (stock of exhaustible natural resources – fossil fuels). Resources, along with capital equipment, are inputs in the production of an aggregate output allocated to consumption and net investment. Resource extraction adds to a stock of GHGs that affects the likelihood for a catastrophic event. If, and when, such an event occurs there is a downscaling of production opportunities. We derive a first-best precautionary global tax on using fossil fuel, which internalizes the present value of (conditional) expected welfare loss of hitting a threshold, as well as a set of risk-modified optimality conditions for overall wealth management, as long as no catastrophe has occurred.

Keywords: wealth management; stochastic tipping points; catastrophic outcome; precautionary taxation; social rates of discount (search for similar items in EconPapers)
JEL-codes: E21 O44 Q32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-env and nep-mac
Date: 2019
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