NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Robert Litterman

Kepos Capital

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NBER Working Papers and Publications

November 2016Applying Asset Pricing Theory to Calibrate the Price of Climate Risk
with Kent D. Daniel, Gernot Wagner: w22795
Pricing greenhouse gas emissions involves making trade-offs between consumption today and unknown damages in the (distant) future. This setup calls for an optimal control model to determine the carbon dioxide (CO2) price. It also relies on society’s willingness to substitute consumption across time and across uncertain states of nature, the forte of Epstein-Zin preference specifications. We develop the EZ-Climate model, a simple discrete-time optimization model in which uncertainty about the effect of CO2 emissions on global temperature and on eventual damages is gradually resolved over time. We embed a number of features including potential tail risk, exogenous and endogenous technological change, and backstop technologies. The EZ-Climate model suggests a high optimal carbon price today t...
 
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