Declining CO₂ price paths.

Area of Science:

• Environmental Economics
• Climate Change Modeling
• Asset Pricing Theory

Background:

• Standard climate-economy models often overlook financial economics insights for pricing emissions.
• Decision-making under risk and uncertainty is crucial for addressing climate change impacts.

Purpose of the Study:

• Introduce EZ-Climate, a novel asset pricing model for calibrating carbon dioxide (CO2) prices.
• Integrate Epstein-Zin preferences to decouple risk and intertemporal substitution in climate-economy analysis.

Main Methods:

• Developed a simple recursive dynamic asset pricing model (EZ-Climate).
• Calibrated the CO2 price path using probabilistic assumptions on climate damages.
• Utilized an Epstein-Zin specification to model societal consumption preferences across time and states of nature.

Main Results:

• EZ-Climate indicates a high initial CO2 price that declines over time, contrary to typical model projections.
• Increased risk aversion leads to higher CO2 prices and risk premiums.
• Delaying emissions pricing incurs substantial economic costs, with a 1-year delay causing over 2% annual consumption loss.

Conclusions:

• The EZ-Climate model offers a new perspective on CO2 pricing, emphasizing immediate action.
• Societal risk aversion and preferences for intertemporal substitution significantly influence optimal climate policy.
• Prompt implementation of carbon pricing is critical to mitigate severe economic consequences of climate change.