As part of the series of the "Finance Research Seminar", VGSF welcomes Eduardo Schwartz from UCLA to present his research papers.
The Carbon Abatement Game
Climate change is considered as one of the major global challenges. Although countries past and future contributions to the accumulation of greenhouse gases in the atmosphere are different, all countries are affected, but not necessarily in the same way (e.g. rising sea levels). This is the reason why it is so hard to reach global agreements on this matter. We study this issue in a dynamic game-theoretical model (stochastic differential game) with multiple countries that are open economies, i.e. we allow for international trade between the countries. Our framework involves stochastic dynamics for CO2-emissions and economic output of the countries. Each country is represented by a recursive-preference functional. Despite its complexity, the model is tractable and we can quantify each country's decision on consumption, investment, carbon abatement and the social cost of carbon, explicitly. One key finding is that both the country-specific and global social cost of carbon are increasing in the trade volume. This result is robust to adding capital transfers between countries. Our numerical examples suggest that disregarding trade might lead to a significant underestimation of the SCC.
Optimal Carbon Abatement in a Stochastic Equilibrium Model with Climate Change
This paper studies a dynamic stochastic general equilibrium model involving climate change. Our frame-work allows for feedback effects on the temperature dynamics. We are able to match estimates of future temperature distributions provided in the fifth assessment report of the IPCC (2014). We compare two approaches to capture damaging effects of temperature on output (level vs. growth rate impact) and combine them with two degrees of severity of this damage (Nordhaus vs. Weitzman calibration). It turns out that the choice of the damage function is crucial to answer the question of how much the distinction between level and growth rate impact matters. The social cost of carbon is similar for frameworks with level or growth rate impact if the potential damages of global warming are moderate. On the other hand, they are more than twice as large for a growth rate impact if damages are presumably severe. We also study the effect of varying risk aversion and elasticity of intertemporal substitution on our results. If damages are moderate for high temperatures, risk aversion only matters when climate change has a level impact on output, but the effects are relatively small. By contrast, the elasticity of intertemporal substitution has a significant effect for both level and growth rate impact. If damages are potentially severe for high temperatures, then the results also become sensitive to risk aversion for both damage specifications.