Working Paper: NBER ID: w16050
Authors: Antony Millner; Simon Dietz; Geoffrey Heal
Abstract: Economic evaluation of climate policy traditionally treats uncertainty by appealing to expected utility theory. Yet our knowledge of the impacts of climate change may not be of sufficient quality to justify probabilistic beliefs. In such circumstances it has been argued that the axioms of expected utility theory may not be the the correct standard of rationality. By contrast several recently-proposed axiomatic frameworks account for ambiguous beliefs. We follow this approach and apply static and dynamic versions of a smooth ambiguity model to climate policy, obtaining general results on the comparative statics of optimal abatement and ambiguity aversion and illustrating this sufficient condition in some simple examples. Greater ambiguity aversion may lead to more or less abatement depending on the details of the model. We then extend our analysis to a dynamic setting and adopt a well-known integrated assessment model to show that the value of emissions abatement increases as ambiguity aversion increases, and that this "ambiguity premium" can in some plausible cases be very large.
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JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ambiguity aversion (D81) | optimal level of abatement (Q52) |
| higher ambiguity aversion (D81) | more weight on models predicting lower expected utilities (D81) |
| more weight on models predicting lower expected utilities (D81) | incentivizing more abatement (Q52) |
| ambiguity aversion (D81) | value of emissions abatement (Q52) |
| ambiguity aversion (D81) | welfare evaluation of climate policies (D69) |