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Optimal Expectations and the Welfare Cost of Climate Variability

Yonas Alem and Jonathan Colmer ()
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Jonathan Colmer: the Grantham Research Institute and Dept of Geography and Environment, London School of Economics, UK

No 578, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: Uncertainty about the future is an important determinant of well-being,especially in developing countries where financial markets and other market failures result in ineffective insurance mechanisms. However, separating the effects of future uncertainty from realised events, and then measuring its impact on utility presents a number of empirical challenges. This paper addresses these issues and shows that increased climate variability (a proxy for future income uncertainty) reduces farmers’ subjective well-being, consistent with the theory of optimal expectations (Brunnermeier & Parker, 2005), using panel data from rural Ethiopia and a new data set containing daily atmospheric parameters. The magnitude of our result indicates that a one standard deviation (7%) increase in climate variability has an equivalent effect on life satisfaction to a two standard deviation (1-2%) decrease in consumption. This effect is one of the largest determinants of life satisfaction in rural Ethiopia.

Keywords: climate variability; uncertainty; subjective well-being; fixed effects (search for similar items in EconPapers)
JEL-codes: C25 D60 I31 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2013-12-10
New Economics Papers: this item is included in nep-agr, nep-ene, nep-env and nep-hap
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Working Paper: Optimal Expectations and the Welfare Cost of Climate Variability (2014) Downloads
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