Extreme events, discounting and stochastic optimization

Ermoliev Y, Ermolieva T, Fischer G, & Makowski M (2010). Extreme events, discounting and stochastic optimization. Annals of Operations Research 177 (1): 9-19. DOI:10.1007/s10479-009-0606-4.

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Abstract

The paper analyzes the implications of extreme events on the proper choice of discounting. Any discouting with constant or declining rates can be linked to random "stopping time" events, which define the internal discount-related horizons of evaluations. Conversely, any stopping time induces a discounting, in particular, with the standard discount rates.The expected duration of the stopping time horizon for discount rates obtained from capital markets does not exceed a few decades and, as such, these rates may significantly underestimate the net benefits of long-term decisions. The alternative undiscounted stopping time criterion allows to induce social discounting focusing on arrival times of potential extreme events rather than horizons of market interests. Induced discount rates are conditional on the degree of social commitment to mitigate risk. In general, extreme events affect these rates, which alter the optimal mitigation efforts that, in turn, change events. The use of undiscounted stopping time criteria requires stochastic optimisation methods.

Item Type: Article
Uncontrolled Keywords: Extreme events; Stopping time; Catastrophic risks; Discounting; Investments; Stochastic optimization
Research Programs: Integrated Modeling Environment (IME)
Modeling Land-Use and Land-Cover Changes (LUC)
Bibliographic Reference: Annals of Operations Research; 177(1):9-19 (June 2010) (Published online 08 September 2009)
Depositing User: IIASA Import
Date Deposited: 15 Jan 2016 08:44
Last Modified: 19 Feb 2016 11:26
URI: http://pure.iiasa.ac.at/9244

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