How certain are we about the certainty-equivalent long term social discount rate?
journal contributionposted on 04.07.2016, 15:04 by Mark Freeman, Ben Groom
Theoretical arguments for using a term structure of social discount rates (SDR) that declines with the time horizon have influenced Government guidelines in the US and Europe. The certainty equivalent discount rate that often underpins this guidance embodies uncertainty in the primitives of the SDR, such as growth. For distant time horizons the probability distributions of these primitives are ambiguous and the certainty equivalent itself is uncertain. Yet, if a limited set of characteristics of the unknown probability distributions can be agreed upon, ‘sharp’ upper and lower bounds can be defined for the certainty-equivalent SDR. Unfortunately, even with considerable agreement on these features, these bounds are widely spread for horizons beyond 75 years. So while estimates of the present value of intergenerational impacts, including the social cost of carbon, can be bounded in the presence of this ambiguity, they typically remain so imprecise as to provide little practical guidance.
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- Business and Economics