Abstract
Downscaled climate change projections for California, when translated into changes in irrigation water delivery and then into profit from agriculture in the Central Valley, show an increase in conventional measures of variability such as the variance. However, these increases are modest and mask a more pronounced increase in downside risk, defined as the probability of unfavorable outcomes of water supply or profit. This paper describes the concept of downside risk and measures it as it applies to outcomes for Central Valley agriculture projected under four climate change scenarios. We compare the effect of downside risk aversion versus conventional risk aversion or risk neutrality when assessing the impact of climate change on the profitability of Central Valley agriculture. We find that, when downside risk is considered, the assessment of losses due to climate change increases substantially.
Highlights
The Synthesis Report of the IPCC’s Fourth Assessment Report famously characterized climate policy as being about managing the risks associated with possible impacts of climate change (IPCC, 2007, p. 22)
Earlier commentators had emphasized the importance of a risk perspective when assessing climate change impacts
In 1992, for example, Cline argued that an ideal impact measurement would “include some form of weighting to take account of policymaker risk aversion
Summary
The Synthesis Report of the IPCC’s Fourth Assessment Report famously characterized climate policy as being about managing the risks associated with possible impacts of climate change (IPCC, 2007, p. 22). The implications of asymmetric rewards for outcomes in different tails of the distribution were first considered in the financial literature, where the term downside risk originated (Markowitz, 1959).1 It was based on the empirical observation that decision makers managing financial investments frequently associate risk with failure to attain a target return.. Following the pioneering work of Mearns et al (1992), many researchers have included risk in their analyses of climate change and have formulated a probabilistic representation of potential impacts. They typically have not factored risk aversion into their analysis and they have not calculated risk premia as part of their measurement of climate damages.
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