Fat Tails and the Social Cost of Carbon
American Economic Review · 2014 · Volume 104 · Issue 5
Abstract
At high enough greenhouse gas concentrations, climate change might conceivably cause catastrophic damages with small but non-negligible probabilities. If the bad tail of climate damages is sufficiently fat, and if the coefficient of relative risk aversion is greater than one, the catastrophe-reducing insurance aspect of mitigation investments could in theory have a strong influence on raising the social cost of carbon. In this paper I exposit the influence of fat tails on climate change economics in a simple stark formulation focused on the social cost of carbon. I then attempt to place the basic underlying issues within a balanced perspective.
Keywords
Project Evaluation, Social Discount Rate, Valuation of Environmental Effects, Climate, Natural Disasters, Global Warming, Environmental Economics: Government Policy
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