N°23-76: International Welfare Gains from Sharing Climate-Risk

In this paper, we consider a heterogeneous agents model of a production economy with uncertain climate change and evaluate the welfare gains from the introduction of securities that pay contingent on average surface temperature and total yearly emissions. Since different regions will be affected dramatically differently by climate change, potential welfare gains from sharing climate risk are large. In our benchmark calibration, the region most affected by climate change gains almost 10 percent in wealth equivalent welfare. This takes into account price effects and assumes no transfers. With transfers, the completion can be Pareto-improving, with the poorest region gaining more than 15 percent. We conduct a global sensitivity analysis where we consider a range of parameter values that are considerably more conservative than in the benchmark. We find that the result of significant welfare gains is robust, although they are, on average, much smaller than in our benchmark. By computing first-order Sobol’ indices, we demonstrate that the main driver of uncertainty is the standard deviation of the equilibrium climate sensitivity.