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Discounting the distant future: How much does model selection affect the certainty equivalent rate?

Ekaterini Panopoulou (), Ben Groom (), Phoebe Koundouri () and Theologos Pantelidis ()

Economics, Finance and Accounting Department Working Paper Series from Department of Economics, Finance and Accounting, National University of Ireland - Maynooth

Abstract: Evaluating investments with long-term consequences using discount rates that decline with the time horizon, (Declining Discount Rates or DDRs) means that future welfare changes are of greater consequence in present value terms. Recent work in this area has turned towards operationalising the theory and establishing a schedule of DDRs for use in cost benefit analysis. Using US data we make the following points concerning this transition: i) model selection has important implications for operationalising a theory of DDRs that depends upon uncertainty; ii) misspecification testing naturally leads to employing models that account for changes in the interest rate generating mechanism. Lastly, we provide an analysis of the policy implications of DDRs in the context of climate change for the US and show that the use of a state space model can increase valuations by 150% compared to conventional constant discounting.

Keywords: long-run discounting; interest rate forecasting; interest rate forecasting; state-space models; regime-switching models; climate change policy (search for similar items in EconPapers)
JEL-codes: C13 C53 Q2 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2005-01
New Economics Papers: this item is included in nep-for
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Journal Article: Discounting the distant future: How much does model selection affect the certainty equivalent rate? (2007) Downloads
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