DP16065 Uncertainty in the Analytic Climate Economy

Author(s): Christian Traeger
Publication Date: April 2021
Keyword(s): Adaptation, climate change, Damages, endogenous risk, Integrated assessment, Long-run risk, risk aversion, Social cost of carbon, stochastic volatility, uncertainty
JEL(s): D61, D80, E13, H23, H43, Q54
Programme Areas: Occasional Paper
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16065

The paper analyzes optimal climate policy under uncertainty. It endows a recent quantitative analytic integrated assessment model (IAM) with long-run risk, adapting methods from the asset pricing literature to deal with endogenous climate risk. The model solves in closed-form for general degrees of risk aversion, stochastic climate feedbacks, and a stochastic damage-adaptation process. The model permits an exact solution of the infinite horizon stochastic fixed-point problem of a complex IAM. The approach facilitates new quantitative evidence for the role of uncertainty as well as analytic insights into the drivers and sensitivities of the optimal carbon tax facing an uncertain future.