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The Climate Risk Premium: How Uncertainty Affects the Social Cost of Carbon

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  • Derek Lemoine

Abstract

I analyze the marginal value of reducing greenhouse gas emissions (the “social cost of carbon”) under uncertainty about warming, under uncertainty about how much warming reduces consumption, and under stochastic shocks to consumption growth. I theoretically demonstrate that each of these sources of uncertainty increases the social cost of carbon under conventional preferences. In a calibrated numerical implementation, uncertainty increases the 200-year social cost of carbon by more than 20%. Uncertainty about the consumption impacts of warming contributes the most to this premium and makes the social cost of carbon sensitive to impacts even after 2400.

Suggested Citation

  • Derek Lemoine, 2021. "The Climate Risk Premium: How Uncertainty Affects the Social Cost of Carbon," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 8(1), pages 27-57.
    • Handle: RePEc:ucp:jaerec:doi:10.1086/710667
    DOI: 10.1086/710667
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    Cited by:

    1. Kevin Rennert & Brian C. Prest & William A. Pizer & Richard G. Newell & David Anthoff & Cora Kingdon & Lisa Rennels & Roger Cooke & Adrian E. Raftery & Hana Sevcikova & Frank Errickson, 2021. "The Social Cost of Carbon: Advances in Long-Term Probabilistic Projections of Population, GDP, Emissions, and Discount Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 52(2 (Fall)), pages 223-305.
    2. Georgii Riabov & Aleh Tsyvinski, 2021. "Policy with stochastic hysteresis," Papers 2104.10225, arXiv.org.
    3. Olijslagers, Stan & van der Ploeg, Frederick & van Wijnbergen, Sweder, 2023. "On current and future carbon prices in a risky world," Journal of Economic Dynamics and Control, Elsevier, vol. 146(C).
    4. Edenhofer, Ottmar & Lessmann, Kai & Tahri, Ibrahim, 2024. "Asset pricing and the carbon beta of externalities," Journal of Environmental Economics and Management, Elsevier, vol. 125(C).
    5. Li, Yue & Goodell, John W. & Shen, Dehua, 2023. "Market reaction to climate risk report disclosures: The roles of investor attention and sentiment," Finance Research Letters, Elsevier, vol. 58(PA).
    6. Huafang Huang & Sharafat Ali & Yasir Ahmed Solangi, 2023. "Analysis of the Impact of Economic Policy Uncertainty on Environmental Sustainability in Developed and Developing Economies," Sustainability, MDPI, vol. 15(7), pages 1-19, March.
    7. Dominika Czyz & Karolina Safarzynska, 2023. "Catastrophic Damages and the Optimal Carbon Tax Under Loss Aversion," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 85(2), pages 303-340, June.
    8. De Bruin, Kelly & Kiran Krishnamurthy, Chandra, 2021. "Optimal Climate Policy with Fat-tailed Uncertainty: What the Models Can Tell Us," Papers WP697, Economic and Social Research Institute (ESRI).
    9. Francisco Costa & Fabien Forge & Jason Garred & João Paulo Pessoa, 2023. "The Impact of Climate Change on Risk and Return in Indian Agriculture," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 85(1), pages 1-27, May.
    10. Sophie Zhou & Frederick van der Ploeg & Rick van der Ploeg, 2023. "Structural Change and the Climate Risk Premium during the Green Transition," CESifo Working Paper Series 10840, CESifo.
    11. Prest, Brian C., 2023. "Disentangling the Roles of Growth Uncertainty, Discounting, and the Climate Beta on the Social Cost of Carbon," RFF Working Paper Series 23-41, Resources for the Future.
    12. Michael T. Kiley, 2024. "Growth at risk from climate change," Economic Inquiry, Western Economic Association International, vol. 62(3), pages 1134-1151, July.
    13. Aharon, David Y. & Baig, Ahmed S. & Jacoby, Gady & Wu, Zhenyu, 2024. "Greenhouse gas emissions and the stability of equity markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 92(C).
    14. Lopez, Ramon E. & Pastén, Roberto & Gutiérrez Cubillos, Pablo, 2022. "Climate change in times of economic uncertainty: A perverse tragedy of the commons?," Economic Analysis and Policy, Elsevier, vol. 75(C), pages 209-225.
    15. Morakinyo O Adetutu & Kayode A Odusanya & Eleni Stathopoulou & Thomas G Weyman-Jones, 2023. "Environmental regulation, taxes, and activism," Oxford Economic Papers, Oxford University Press, vol. 75(2), pages 460-489.
    16. Zhang, Dayong & Wu, Yalin & Ji, Qiang & Guo, Kun & Lucey, Brian, 2024. "Climate impacts on the loan quality of Chinese regional commercial banks," Journal of International Money and Finance, Elsevier, vol. 140(C).

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