The Social Discount Rate under Intertemporal Risk Aversion and Ambiguity

Following the Stern review of climate change the numerical choice of the social discount rate has been identified as one of the most crucial determinants of optimal policy recommendations for greenhouse gas mitigation policies. In this paper I point out two closely related contributions to the social discount rate in an uncertain world that have been overlooked in the debate. First, the standard model that has been employed in the debate contains an implicit assumption of (intertemporal) risk neutrality, stemming from the assumption that Arrow Pratt risk aversion is equivalent to the aversion to intertemporal consumption fluctuations. Second, the recent decision theoretic literature has developed various models that generalize the description of uncertainty in order to explain observed differences in the attitude with respect to risk versus ambiguous uncertainty. I show how these two extensions of the standard model modify the (certainty equivalent) social discount rate and point out that there is reason to believe that the additional contribution from intertemporal risk aversion is significantly larger than the term capturing risk in the social discount rate based on the standard model. JEL Codes: D61, D81, D90, H43, Q00, Q54