Robert S. Pindyck, July 2012
I examine the risk/return tradeoff for environmental investments, and its implications for policy choice. Consider a policy to reduce carbon emissions. To what extent does the value of such a policy depend on the expected future damages from global warming versus uncertainty over those damages, i.e., on the expected benefits from the policy versus their riskiness? And to what extent should the policy objective be a reduction in the expected temperature increase versus a reduction in risk? Using a simple model of a stock externality (e.g., temperature) that evolves stochastically, I examine the "willingness to pay"