Models-as-Usual for Unusual Risks? On the Value of Catastrophic Climate Change

We study the role of alternative intertemporal preference representations in a model of economic growth, stock pollutant and endogenous risk of catastrophic collapse. We contrast the traditional “discounted utility” model, which assumes risk neutrality with respect to intertemporal utility, with a multiplicative choice model that displays risk aversion in that dimension. First, we show that both representations of preferences can rationalize the same “business as usual” economy for a given interest rate and no pollution externality. Second, once we introduce a collapse risk whose hazard rate is a function of the pollution stock, multiplicative preferences recommend a much more stringent policy response. An illustration in the context of climate change indicates that switching to the multiplicative preference representation has a similar effect, in terms of policy recommendations, as scaling up the schedule of the hazard rate by a factor of 100.