May 18, 2009

Discounting investments in mitigation and adaptation: a dynamic stochastic general equilibrium approach of climate change

We use a dynamic stochastic general equilibrium model to determine efficient discount rates for climate (mitigation and adaptation) and non-climate investment in the face of climate change.

Our main result is that the non-diversifiable risk in the economy may be related to both shocks in aggregate wealth and shocks in global average temperature. Therefore, both aggregate wealth and global average temperature will carry a risk premium reflecting their contribution to the total amount of non-diversifiable risk. We characterize both climate and non-climate investments by means of a contingent claim and show that climate and non-climate investments will in general be discounted at different rates. We discuss the conditions under which the discount rates of climate investments will be lower than the discount rate of non-climate investments.

September 2013: There is an updated version of this paper availlable, read CPB Discussion Paper 257.