Wealth Management and Uncertain Tipping Points
Link to article:
Strøm, Steinar, Jon Vislie
CESifo working paper no 7487
We analyze optimal wealth management, within a global setting, where accumulation of GHGs caused by extraction of fossil resources affects the probability distribution for hitting a threshold or tipping point, indicating a climate change. We derive an optimal strategy for overall wealth management, within a Ramsey-Hotelling-framework. We have two assets; one being reproducible (reversible capital equipment) and another being non-reproducible (stock of exhaustible natural resources – fossil fuels). Resources, along with capital equipment, are inputs in the production of an aggregate output allocated to consumption and net investment. Resource extraction adds to a stock of GHGs that affects the likelihood for a catastrophic event. If, and when, such an event occurs there is a downscaling of production opportunities. We derive a first-best precautionary global tax on using fossil fuel, which internalizes the present value of (conditional) expected welfare loss of hitting a threshold, as well as a set of risk-modified optimality conditions for overall wealth management, as long as no catastrophe has occurred.
E210, O440, Q320.
wealth management, stochastic tipping points, catastrophic outcome, precautionary taxation, social rates of discount.
Project:Oppdragsgiver: Norges forskningsråd
Oppdragsgivers prosjektnr.: 209698
Frisch prosjekt: 3100 - Oslo Center for Research on Environmentally friendly Energy (CREE)