Inertia Risk: Improving Economic Models of Catastrophes* |
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Authors: | Anne-Sophie Crépin Eric Nævdal |
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Affiliation: | 1. The Beijer Institute of Ecological Economics, SE-104 05 Stockholm, Sweden;2. The Frisch Centre, NO-0349 Oslo, Norway |
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Abstract: | We model endogenous catastrophic risk in a new way. We call it “inertia risk”, which accounts for delays between physical variables and the hazard rate – a characteristic often observed in reality. The added realism significantly affects optimal policies relative to the standard model of catastrophic risk. The probability of a catastrophe occurring at some point in time can span the entire interval [0,1], and is not 0 or 1 as is typical in standard models. Inertia risk can also generate path dependences. We illustrate the implications for policy in a simple model of climate change. |
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Keywords: | Catastrophic risk climate change lagged effects resource management |
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