Term structures and scenario-based social discount rates under smooth ambiguity

Abstract

Many studies estimate social discount rates based on the Ramsey rule. The rule has been augmented in various ways in order to reflect the decision maker’s attitude toward risk and uncertainty. In this article, we adopt the recursive utility with ambiguity of Ju and Miao and develop a general social discount rate formula via the utility gradient method. The derived formula allows us to obtain the three-way explicit separation of risk aversion, intertemporal substitution, and ambiguity aversion as in Traeger. It also goes beyond the classical two-period setting and thus term structures of social discount rates under ambiguity can be studied. Due to the generality of this approach, we can directly apply the well-known growth scenarios under climate change so as to derive scenario-based social discount rates, which can be used as a guide in practice to assess climate change policies or related projects.

Acknowledgments

The authors appreciate valuable feedback from anonymous reviewers and the Editor that helped improve the manuscript.

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Additional information

Funding

This work was supported by the Ministry of Education of the Republic of Korea and the National Research Foundation of Korea (NRF-2018S1A5B6069196).

Notes on contributors

Dowon Kim

Dowon Kim works as a data scientist at Meritz Fire & Marin Insurance. His current research interests include energy economics and stochastic optimization. He received a B.S. in industrial engineering from Pusan National University, an M.S. and Ph.D. in industrial & systems engineering from KAIST.

Kyoung-Kuk Kim

Kyoung-Kuk Kim is an associate professor in the Department of Industrial & Systems Engineering at KAIST. He is interested in stochastic modeling and simulation with applications to financial engineering, risk management, and operations management. He received a B.S. in mathematics from Seoul National University, an M.S. in mathematics from Stanford University, and a Ph.D. from Columbia Business School.

Jiwoong Lee

Jiwoong Lee is an assistant professor in the Department of Economics at Pukyong National University. His research interests are game theory and climate change economics. He earned a B.S. in mathematics from Seoul National University, an M.S. in economics from Toulouse School of Economics, and a Ph.D. in economics from Maastricht University.