Building Risk into the Mitigation/Adaptation Decisions simulated by Integrated Assessment Models

This paper proposes an operationally simple and easily generalizable methodology to incorporate climate change damage uncertainty into Integrated Assessment Models (IAMs). First uncertainty is transformed into a risk measure by extracting damage distribution means and variances from an ensemble of socio economic and climate change scenarios. Then a risk premium is computed under different degrees of risk aversion, quantifying what society would be willing to pay to insure against the uncertainty of the damages. Our estimates show that the premium for the risk is a potentially significant addition to the “standard average damage”, but highly sensitive to the attitudes toward risk. In the last research phase, the risk premium is incorporated into the climate change damage function of a widely used IAM which shows, consequently, a substantial increase in both mitigation and adaptation efforts, reflecting a more precautionary attitude by the social planner. Interestingly, adaptation is stimulated more than mitigation in the first half of this century, while the situation reverses afterwards.