Discount Rates, Social Judgments, Individuals’ Risk Preferences, and Uncertainty

Author: 
David A. Weisbach
with: 
Louis Kaplow

The choice of the proper discount rate is important in the analysis of projects whose costs and benefits extend into the future, a particularly striking feature of policies directed at climate change. Much of the literature, including prominent work by Arrow et al. (1996), Stern (2007, 2008), and Dasgupta (2008), employs a reduced-form approach that conflates social value judgments and individuals’ risk preferences, the latter raising an empirical question about choices under uncertainty rather than a matter for ethical reflection. This article offers a simple, explicit decomposition that clarifies the distinction, reveals unappreciated difficulties with the reduced-form approach, and relates them to the literature. In addition, it explores how significant uncertainty about future consumption, another central factor in climate policy assessment, raises further complications regarding the relationship between social judgments and individuals’ risk preferences.