On Modeling and Interpreting the Economics of Catastrophic Climate Change

Abstract

With climate change as prototype example, this paper analyzes the implications of structural uncertainty for the economics of low-probability, high-impact catastrophes. Even when updated by Bayesian learning, uncertain structural parameters induce a critical "tail fattening" of posterior-predictive distributions. Such fattened tails have strong implications for situations, like climate change, where a catastrophe is theoretically possible because prior knowledge cannot place sufficiently narrow bounds on overall damages. This paper shows that the economic consequences of fat-tailed structural uncertainty (along with unsureness about high-temperature damages) can readily outweigh the effects of discounting in climate-change policy analysis. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Fat-Tailed Uncertainty in the Economics of Catastrophic Climate Change

“…In my article (Weitzman (2009)), the main question I attempted to address was whether such intuitive sensitivity is re ‡ecting some deeper principle. My answer was that there is a basic underlying theoretical principle that indeed points in this direction.…”

“…Structural uncertainty essentially means that the probabilities are unsure. A formal Bayesian translation might be that the structural parameters of the relevant PDFs are themselves uncertain and have their own 11 There is some wiggle room in the de…nition of what constitutes a fat-tailed PDF or a thin-tailed PDF, but everyone agrees that probabilities declining exponentially or faster (like the Normal) are thin tailed, while probabilities declining polynomially or slower (like the Pareto) are fat tailed. The standard example of a fat-tailed PDF is the power law (aka Pareto aka inverted polynomial) distribution, although, for example, a Student-t or inverted-gamma PDF is also fat-tailed.…”

Discounting behavior and environmental decisions.

“…In most policy simulations, these reductions are small and gradual. However, Weitzman (2009) has looked at the ties between low-probability catastrophic events and discount rates, finding that this extreme uncertainty can make standard cost benefit analyses arbitrarily inaccurate.…”

New Frontiers in the Economics of Climate Change

“…A paper by Weitzman (2009) has focused attention on the matter. Weitzman's analysis is motivated by the large uncertainty around estimates of the climate sensitivity (i.e.…”