Abstract
The social cost of carbon is the expected present value of damages from emitting one ton of carbon today. We use perturbation theory to derive an approximate tractable expression for this cost adjusted for climatic and economic risk. We allow for different aversion to risk and intertemporal fluctuations, skewness and dynamics in the risk distributions of climate sensitivity and the damage ratio, and correlated shocks. We identify prudence, insurance, and exposure effects, reproduce earlier analytical results, and offer analytical insights into numerical results on the effects of economic and damage ratio uncertainty and convex damages on the optimal carbon price. (JEL E12, G22, H23, O44, Q35, Q51, Q54)
Highlights
The social cost of carbon (SCC) is the expected present discounted value of all future marginal damages resulting from emitting one ton of carbon today.1 The risk-adjusted SCC incorporates uncertainties2 associated with climate and the economy
1 and 2 imply that temperature uncertainty and damage ratio uncertainty call for a higher SCC, where the adjustment to the SCC is larger if damages are more convex, the distribution of uncertainty is wider and more right-skewed, uncertainty arises on shorter horizons, and the r isk-adjusted social discount rate and carbon decay rate are smaller
We have derived a tractable closed-form approximate solution for the optimal risk-adjusted SCC under economic and climatic uncertainties allowing for skewed distributions and accounting for the time scales on which the uncertainties arise and their correlation
Summary
The social cost of carbon (SCC) is the expected present discounted value of all future marginal damages resulting from emitting one ton of carbon today. The risk-adjusted SCC incorporates uncertainties associated with climate and the economy. To evaluate the SCC, one must know how much of one ton of carbon emitted today is still left in the atmosphere at each future time; the effect of the atmospheric carbon stock on temperature; the effect of temperature on damages to aggregate output and consumption; and the marginal utility of consumption at all instants of time All of these effects are subject to uncertainty. Our closed-form expression for the optimal SCC is in the spirit of the rule derived by Golosov et al (2014).3 It has the usual precautionary, insurance and risk-exposure determinants of the risk-adjusted social discount rate and the SCC resulting from macroeconomic uncertainty, but adds multiplicative adjustment factors to allow for the uncertainties regarding the carbon stock, climate sensitivity, and the damage ratio. We derive two main results. By focusing on the leading-order effects of uncertainty, Result 1 gives a closed-form solution for the optimal SCC if the damage ratio is proportional to the atmospheric carbon stock and there is no delay in the THE AMERICAN ECONOMIC REVIEW
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
