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Inertia Risk: Improving Economic Models of Catastrophes *
Author(s) -
Crépin AnneSophie,
Nævdal Eric
Publication year - 2020
Publication title -
the scandinavian journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.725
H-Index - 64
eISSN - 1467-9442
pISSN - 0347-0520
DOI - 10.1111/sjoe.12381
Subject(s) - inertia , economics , econometrics , hazard , path dependent , interval (graph theory) , mathematical economics , mathematics , physics , chemistry , organic chemistry , classical mechanics , combinatorics
We model endogenous catastrophic risk in a new way. We call it “inertia risk”, which accounts for delays between physical variables and the hazard rate – a characteristic often observed in reality. The added realism significantly affects optimal policies relative to the standard model of catastrophic risk. The probability of a catastrophe occurring at some point in time can span the entire interval [0,1], and is not 0 or 1 as is typical in standard models. Inertia risk can also generate path dependences. We illustrate the implications for policy in a simple model of climate change.