Cost–benefit analysis under uncertainty — A note on Weitzman's dismal theorem

Abstract

Weitzman's (2009) famous dismal theorem argues that “fat tails” in the distribution of warming may pose problems for cost–benefit analysis as it may imply that society might be willing to exchange today's consumption for future consumption at an infinite rate. His analysis is based on the stochastic discount factor. We show that in situations in which the stochastic discount factor is applicable, it is optimal for society to devote only a finite amount of resources to protect against climate change. For general assumptions on the investment returns, cost–benefit analysis must consider the joint distribution of the marginal utility of future consumption and marginal returns to investment in the different future states of nature. We explore the range of situations under which challenges for applying cost–benefit analysis under uncertainty remain.