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Optimal Expectations and the Welfare Cost of Climate Variability

Yonas Alem and Jonathan Colmer

Discussion Papers from Resources For the Future

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 the impact of uncertainty on utility, presents a number of empirical challenges. This paper aims to address these issues and provides supporting evidence to show 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 AER), 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: separated; by; commas (search for similar items in EconPapers)
JEL-codes: C25 D60 I31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-agr, nep-ene, nep-env, nep-ger, nep-hap and nep-upt
Date: 2014-03-05
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Working Paper: Optimal Expectations and the Welfare Cost of Climate Variability (2013) Downloads
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