Evaluation of long-dated assets : The role of parameter uncertainty

Gollier, Christian (2012) Evaluation of long-dated assets : The role of parameter uncertainty. TSE Working Paper, n. 12-361, Toulouse

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Official URL: http://tse-fr.eu/pub/26574


Because of the uncertainty about how to model the growth process of our economy, there is still
much confusion about which discount rates should be used to evaluate actions having long-lasting
impacts, as in the contexts of climate change, social security reforms or large public infrastructures
for example. We characterize efficient discount rates when the growth of log consumption follows
a random walk with uncertain parameters. We examine different models in which the parametric
uncertainty affects the trend and the volatility of growth, or the frequency of catastrophes. This
uncertainty implies that the term structures of the risk free discount rate and of the aggregate risk
premium are respectively decreasing and increasing. It also implies that the discount rate is
increasing with maturity if the beta of the investment is larger than half of relative risk aversion.
Another important consequence of parametric uncertainty is that the risk premium is not
proportional to the beta of the investment. Finally, we apply our findings to the evaluation of
climate change policy. We argue in particular that the beta of actions to mitigate climate change is
relatively large, so that the term structure of the associated discount rates should be increasing.

Item Type: Monograph (Working Paper)
Language: English
Date: November 2012
Place of Publication: Toulouse
Uncontrolled Keywords: asset prices, term structure, risk premium, decreasing discount rates, parametric uncertainty, CO2 beta, rare events, macroeconomic catastrophes
JEL codes: E43 - Determination of Interest Rates; Term Structure of Interest Rates
G11 - Portfolio Choice; Investment Decisions
G12 - Asset Pricing; Trading volume; Bond Interest Rates
Q54 - Climate; Natural Disasters
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 09 Jul 2014 17:31
Last Modified: 07 Mar 2018 13:22
OAI ID: oai:tse-fr.eu:26574
URI: http://publications.ut-capitole.fr/id/eprint/15455

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