Exercises in hedging against extreme consequences of global change and the expected value of information

Global Environmental Change

Volumn 6, Issue 2, 1996, Pages 87-101

  Yohe, Gary ^a  

^a WESLEYAN UNIVERSITY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

CLIMATE CHANGE; ENVIRONMENTAL ECONOMICS; ENVIRONMENTAL POLICY; GLOBAL CHANGE; HEDGING; POLICY IMPLICATION;

EID: 0030153453     PISSN: 09593780     EISSN: None     Source Type: Journal    
DOI: 10.1016/0959-3780(96)00004-0     Document Type: Article

References (20)

1. W Nordhaus and G Yohe, 'Future carbon dioxide emissions from fossil fuels' in Changing Climate, National Academy Press, Washington, DC, 1983
2. W Nordhaus, 'Expert opinion on climate change', The American Scientist, Vol 82, pp 45-51, January/February, 1994a;
3. W Nordhaus, Managing the Global Commons: The Economic of Climate Change, MIT Press, Cambridge, MA, 1994b
4. G Yohe, 'Constant elasticity of substitution, production functions with three or more inputs', Economics Letters, Vol 15, pp 29-34, 1983
5. Nordhaus and Yohe, Economics Letters, op cit, Ref 1
6. W Nordhaus, 'An optimal transition path for controlling greenhouse gases' Science, Vol 258, pp 1315-1319, November 1992;
7. Nordhaus, 1994b, Science, op cit, Ref 2
8. W Cline, The Economics of Global Warming. Institute for International Economics, Washington, DC, 1992
9. Other structures may be employed in lieu of Equation (7) as more understanding of potential damages is generated. As it stands, now, the parameters a and θ are determined by the estimated annual loss (in terms of percent of global GDP) that might be associated with an effective doubling of atmospheric carbon concentrations and some conjecture about how quickly those damages might be climbing at that (future) point in time. Cline The Economics of Global Warming, op cit, Ref 6,
10. and Nordhaus, 1994a, The Economics of Global Warming, op cit, Ref 2, adopt a quadratic structure with doubling causing GDP to fall by 1.3%. As a result, θ = 2 and a = 0.013
11. There is a technical reason for avoiding complete dynamic optimization, as well. To our understanding, all solution packages require a complete and constant formal ization of the production relationship; they cannot, therefore, be expected to accommodate the dynamic approximation procedure that allows for arbitrary elasticities of substitution between energy and labour and between two types of energy
12. Experiments that compare applications of this information constrained second best computation scheme along the media emissions scenario with the original DICE results show reasonable convergence in emissions, concentrations, changes in temperature, and carbon taxes through 2100
13. Equality of savings and investment is implicit in this construction, so care needs to be taken in practice to see that Equations (12) and (13) do not lead to unreasonable changes in savings rates
14. The damage component of the model parallels exactly the structure employed by Nordhaus in the DICE Model, The Economics of Global Warming, op cit, Ret 2
15. Note that technological change in energy [h(t)] and the elasticity of substitution between fossil and non-fossil fuel again energy, as in the original Nordhaus-Yohe work, op cit, is among the most significant sources of uncertainty
16. G Yohe, Toward a general methodology for selecting "interesting" greenhouse scenarios', Climate Research, Vol 1, pp 169-177, 1991
17. The procedure that lead to the selection of seven representative trajectories also creates a specific partition of all possible trajectories - partitions that were also defined by the minimizing procedure. The procedure starts with an arbitrary partitioning for which error minimizing representatives were chosen. In the next step, the highest member of the lowest partition was moved to the next highest partition and the calculations redone. If the sum of squared errors fell, then another member was moved up; if not, then it was returned to the lowest partition. This trial and error method was applied to all of the partition boundaries until no more error reducing moves were available. There are theorems that describe when this procedure converges to a unique outcome. Their conditions appear to have been met by the collection of 81 emissions values, but confidence can be placed on the fact that starting from different initial partitions and working from both the bottom up and the top down produced the same results
18. W Nordhaus, 'Notes on scenarios for uncertainty group', communicated June, 1995
19. Nordhaus, Notes on Scenarios for Uncertainty Group, op cit, Ref 15
20. The expected discounted cost of hedging is computed as the expected discounted value of perfect information in 1995 assuming (1) a 3% rate of time preference (ie, ρ = 0.03), (2) logarithmic utility in per capita consumption and (3) a standard Ramsey-style growth discounting procedure for goods and services that adds the observed annual rate of growth in per capita consumption to ρ. It is the difference between the expected net benefit of optimal policies applied to U0 and U1 (eg) separately (weighted by their respective relative likelihoods) and the expected net benefit of hedging with the same tax through 2100 and then correcting to the then reveal actual trajectory (again, eg, U0 and U1). Benefits are climate based damages avoided; costs are standard dead-weight loss areas.