Optimal climate policy under tipping risk and temporal risk aversion
We investigate the implications of absolute risk aversion with respect to intertemporal utility, i.e. temporal risk aversion, in the presence of a stylized climate tipping risk affecting productivity irreversibly. Optimal climate policy is more stringent under temporal risk aversion, in order to reduce all present and future probabilities of crossing the tipping point and avoid a situation where all generations are badly off. Temporal risk aversion implies a 30% increase in the social cost of carbon (SCC) under our benchmark calibration and for a 10% irreversible increase in the level of economic damage from climate change. The optimal SCC under temporal risk aversion increases sharply with the level of damage brought by a potential tipping point.