- Economics meets statistics: Expected utility and catastrophic risk
- Number of pages
- Odense, Amsterdam, Tilburg and Burnaby: University of Southern Denmark, University of Amsterdam, EURANDOM, CentER, Tilburg University, Simon Fraser University
- Document type
- Working paper
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
Amsterdam Business School Research Institute (ABS-RI)
We derive necessary and sufficient conditions on the utility function of the expected utility model to avoid fragility of a cost-benefit analysis to distributional assumptions. The conditions ensure that expected (marginal) utility remains finite also under heavy-tailed distributional assumptions.
We apply these conditions to the context of economy-climate catastrophe. We specify a stylized two-period stochastic economy-climate model. We show that, under expected power utility, the model is fragile to heavy-tailed distributional assumptions and, based on our derived conditions, we solve the model for two cases with compatible economic and statistical assumptions.
- July 24, 2013