Working Paper: NBER ID: w15373
Authors: Robert S. Pindyck; Neng Wang
Abstract: How likely is a catastrophic event that would substantially reduce the capital stock, GDP and wealth? How much should society be willing to pay to reduce the probability or impact of a catastrophe? We answer these questions and provide a framework for policy analysis using a general equilibrium model of production, capital accumulation, and household preferences. Calibrating the model to economic and financial data, we estimate the mean arrival rate of shocks and their size distribution, the tax on consumption society would accept to limit the maximum size of a catastrophic shock, and the cost to insure against its impact.
Keywords: catastrophic risk; general equilibrium; policy analysis; insurance; economic consequences
JEL Codes: E20; G01; H56
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Likelihood of experiencing a catastrophic event (H84) | Diminish the capital stock and wealth (E21) |
| Behavior of economic and financial variables (E32) | Likelihood of experiencing a catastrophic event (H84) |
| Distribution of equity returns (C46) | Expected loss from catastrophic events (G52) |
| Characteristics of shocks (E32) | Maximum permanent consumption tax that households would accept (H31) |
| Adjustment costs (J30) | Willingness to pay for risk reduction (D81) |
| Without adjustment costs (D24) | Willingness to pay for risk reduction would be lower (D11) |
| Characteristics of shocks (E32) | Equilibrium price of insurance against catastrophic risks (G52) |