Inertia risk: improving economic models of catastrophes

Author(s): Crépin, A-S., Nævdal, E.
In: The Scandinavian Journal of Economics. Doi: 10.1111/sjoe.12381
Year: 2019
Type: Journal / article
Theme affiliation: Complex Adaptive Systems
Link to centre authors: Crépin, Anne-Sophie
Full reference: Crépin, A-S., Nævdal, E. 2019. Inertia Risk: Improving Economic Models of Catastrophes. The Scandinavian Journal of Economics. Doi: 10.1111/sjoe.12381

Summary

We model endogenous catastrophic risk in a new way that we term inertia risk, which accounts for delays between physical variables and the hazard rate — a characteristic often observed in reality. The added realism significantly impacts optimal policies relative to the standard model of catastrophic risk. The probability of a catastrophe occurring at some point in time may span the entire interval [0, 1] and is not 0 or 1 as is typical in standard models. Inertia risk may also generate path dependencies. We illustrate the implications for policy in a simple model of climate change.

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