Ambiguous tipping points
D. Lemoine and C. P. Traeger
Journal of Economic Behavior & Organization (December 2016)
Abstract We analyze the policy implications of aversion to Knightian uncertainty (ambiguity) about the possibility of tipping points. We demonstrate two channels through which uncertainty aversion affects optimal policy in the general setting. The first channel relates to the policy's effect on the probability of tipping, and the second channel to its differential impact in the pre- and post-tipping regimes. We then extend a recursive dynamic model of climate policy and tipping points to include uncertainty aversion. Numerically, aversion to Knightian uncertainty in the face of an ambiguous tipping point increases the optimal tax on carbon dioxide emissions, but only by a small amount.
keywords: Tipping point; Ambiguity; Knightian uncertainty; Threshold; Regime shift; Climate; Hazard; Integrated assessment; Dynamic programming; Social cost of carbon; Carbon tax