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Pricing Carbon Under Economic and Climactic Risks: Leading-Order Results from Asymptotic Analysis

Ton van den Bremer and Frederick (Rick) van der Ploeg ()

No 12642, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Leading-order results from asymptotic analysis for the optimal price of carbon under uncertainty are derived from a macroeconomic continuous-time DSGE model with AK growth, energy use, adjustment costs, recursive utility and costs of global warming. We consider non-climatic productivity growth uncertainty, atmospheric carbon uncertainty, climate sensitivity uncertainty and climate damage uncertainty. Explicit expressions are derived that show the leading-order dependence of the optimal carbon price on these uncertainties, the various climate betas, risk aversion, intergenerational inequality aversion and convexity of the climate damage specification. Our solution allows for skewness and mean reversion in stochastic shocks to the climate sensitivity and damage coefficients. The resulting rule for the optimal risk-adjusted carbon price incorporates precautionary, risk-insurance and risk-exposure effects to deal with future economic and climatic risks. The stochastic processes are calibrated and used to estimate and interpret the impact of each source of uncertainty on the optimal risk-adjusted carbon price.

Keywords: climate betas; Insurance; mean reversion; precaution; Skewness (search for similar items in EconPapers)
JEL-codes: H21 Q51 Q54 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-ene, nep-env and nep-ias
Date: 2018-01
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