Optimal CO2 control policy with stochastic losses from temperature rise

In this paper, we present a new specification of warming cost and incorporate it into an integrated assessment model of global climate change. In the new specification, warming cost is represented as the product of possible large warming related welfare losses which occur with small probabilities that depend on the amount of temperature rise. This is in contrast to the conventional representation of warming cost as a deterministic function of temperature rise. To avoid curse of dimensionality problems, we assume that losses affect the utility of consumption without directly affecting consumption itself, and that the probability of losses occurring is independent of the number of losses that may have previously occurred. The results we obtain using this new approach depend importantly on the specification of the loss probability function. Nevertheless, our results are qualitatively similar to previous results obtained using a deterministic specification of warming cost, in which cost is a cubic function of temperature rise.