Mark C. Freeman

Biodiversity valuation and the discount rate problem

Purpose - The aim of this paper is to demonstrate that the application of standard environmental accounting practices for estimating long-term discount rates is likely to lead to the rejection of biodiversity-sensitive projects that are in the greater societal good. Design/methodology/approach - The authors combine estimates of marginal ecosystem damages from two forestry case studies, one local, one global, with ten different term structures of discount rates taken from both the academic literature and policy choices to calculate present values. Findings - Standard environmental accounting approaches for estimating the long-term discount rate result in the under-valuation of projects that are sensitive to biodiversity conservation. Research limitations/implications - This paper is set within a full cost accounting (FCA) framework, and therefore has the limitations that generally follow from taking this approach to biodiversity problems. Recommended extensions include looking at broader ranges of biodiversity costs and benefits. Social implications - Unless environmental accountants engage with environmental economists over the issue of intergenerational discount rates, then it is likely that socially responsible managers will reject projects that are in the greater societal good. Originality/value - The paper introduces both normative discount rates and declining discount rates to estimates of shadow environmental provisions within FCA and contrasts these with current environmental accounting practices. It also provides two detailed case studies that demonstrate the extent to which biodiversity-sensitive investment choices are likely to be undervalued by managers who follow current accounting recommendations concerning the appropriate choice of discount rate.

Positively Gamma Discounting: Combining the Opinions of Experts on the Social Discount Rate

The aggregated term structure of social discount rates that results from Weitz-mans (2001) survey of expert opinion is shown to be highly sensitive to the nature of the responses. If variation re.ects irreducible differences in ethical judgements, the term structure can decline rapidly. If variation occurred because respondents were forecasting future rates under uncertainty, the term structure is much flatter because additional experts provide new information. The former approach triples the social cost of carbon when compared to the latter. The distinction between heterogeneity and uncertainty illustrates the need for a nuanced treatment of survey data in intergenerational policy making.

Climate Sensitivity Uncertainty: When is Good News Bad?

Climate change is real and dangerous. Exactly how bad it will get, however, is uncertain. Uncertainty is particularly relevant for estimates of one of the key parameters: equilibrium climate sensitivity—how eventual temperatures will react as atmospheric carbon dioxide concentrations double. Despite significant advances in climate science and increased confidence in the accuracy of the range itself, the ‘likely’ range has been 1.5–4.5°C for over three decades. In 2007, the Intergovernmental Panel on Climate Change (IPCC) narrowed it to 2–4.5°C, only to reverse its decision in 2013, reinstating the prior range. In addition, the 2013 IPCC report removed prior mention of 3°C as the ‘best estimate’. We interpret the implications of the 2013 IPCC decision to lower the bottom of the range and excise a best estimate. Intuitively, it might seem that a lower bottom would be good news. Here we ask: when might apparently good news about climate sensitivity in fact be bad news in the sense that it lowers societal well-being? The lowered bottom value also implies higher uncertainty about the temperature increase, definitely bad news. Under reasonable assumptions, both the lowering of the lower bound and the removal of the ‘best estimate’ may well be bad news.

Yes, We Should Discount the Far-Distant Future at its Lowest Possible Rate: A Resolution of the Weitzman-Gollier Puzzle

In this paper the author proves that the Expected Net Future Value (ENFV) criterion can lead a risk neutral social planner to reject projects that increase expected utility. By contrast, the Expected Net Present Value (ENPV) rule correctly identifies the economic value of the project. While the ENFV increases with uncertainty over future interest rates, the expected utility decreases because of the planners desire to smooth consumption across time. This paper therefore shows that Weitzman (1998) is right and that, within his economy, the far-distant future should be discounted at its lowest possible rate.

Estimating the equity premium

Accurate estimation of the equity premium (the expected difference between the returns to a well-diversified stock market portfolio and a riskfree asset) is of central importance in many applications of finance theory including project appraisal and portfolio selection. The standard approach is to take the average observed excess returns to the market over some recent time period (sometimes referred to as the ex post equity premium) and apply this as an unbiased estimate of the ex ante equity premium. The paper reviews the problems associated with such an approach and contrasts it with alternative theoretical techniques.

Credit risk management: The use of credit derivatives by non‐financial corporations

Purpose – This paper aims to explore the possible use of credit derivatives by corporate treasurers. Corporations have, in recent years, grown comfortable with the idea of using traditional derivative products to hedge their exposure to, for example, interest rate and foreign exchange risk. Credit risk, on the other hand, has proven a more difficult animal to tame. Whilst avenues for the management of credit risk do exist, for example, by the use of traditional insurance products and letters of credit, such means are not always convenient.Design/methodology/approach – In this paper, both the academic and practitioner literature on credit derivatives and their application are reviewed. Then, by means of some simple numerical examples, the possible uses to which corporate treasurers might put credit default swaps and total return swaps are illustrated.Findings – The credit derivatives market is, at present, dominated by large banks and insurance companies who trade credit exposure among themselves. As the c...

Pension plan solvency and extreme market movements: a regime switching approach

We develop and test a new approach to assess defined benefit (DB) pension plan solvency risk in the presence of extreme market movements. Our method captures both the ‘fat-tailed’ nature of asset returns and their correlation with discount rate changes. We show that the standard assumption of constant discount rates leads to dramatic underestimation of future projections of pension plan solvency risk. Failing to incorporate leptokurtosis into asset returns also leads to downward biased estimates of risk, but this is less pronounced than the time-varying discount rate effect. Further modifying the model to capture the correlation between asset returns and the discount rate provides additional improvements in the projection of future pension plan solvency. This reduces the perceived future risk of underfunding because of the negative correlation between interest rate changes and asset returns. These results have important implications for those with responsibility for balancing risk against expected return when seeking to improve the current poor funding positions of DB pension schemes.

Asset pricing with jump/diffusion permanent income shocks☆

Abstract By assuming that all uninsurable risk is permanent, a closed form multi-period, multiple agent and multiple asset incomplete market asset pricing model is presented that allows for jump as well as diffusion risk to personal income.

Debate: Why is everyone except me wrong about climate change policy?

This article aims to stimulate debate around publicly-expressed, opposed opinions, on climate change and to briefly explore the reasons that could drive these contrary views. The strong association between an individual’s concern about the threat of climate change, and whether they more generally lie on the right or left of the political spectrum, has been extensively evidenced in the academic literature; see, for example, McCright et al. (2016) and the references therein. Results from a Gallup poll in June 2017 indicated that this partisan divide between Republicans and Democrats in the USA is growing ever wider. Compared to a decade earlier, there has been a rise of over 10 percentage points in Democrats who worry a great deal about climate change (66% from 55%), while this percentage for Republicans has fallen by six percentage points from an already much lower base (18% from 24%). This helps explain the Trump administration’s position on the Paris Agreement. In the highly-heated exchanges in online forums, those on the political left often assign the unwillingness of ‘climate deniers’ to accept the urgency to act on reducing greenhouse gas emissions as evidence of narrow vested interests, stubbornness and general scientific stupidity. Similarly, those who make the strongest case for climate change action are disparaged as ‘watermelons’ (Delingpole, 2012)—green on the outside and red on the inside, where environmentalism is used as a stealth mechanism to action a socialist agenda via the back door. While there is no doubt some truth in both these sets of accusations for a minority of people, they do not strike me as being helpful for a meaningful discussion on how to move forward the policy agenda. As Sun Tzu noted in The Art of War, ‘If you know yourself but not the enemy, for every victory gained you will also suffer a defeat’. Ridiculing those who disagree with us cannot fully equate to understanding as, even among the expert community, Pindyck (2016) has documented large disagreements over how much should be spent to reduce carbon dioxide emissions. I therefore briefly propose a framework that combines moral foundation theory, rational learning, and differences in individual ethical preferences that I think will allow for improved discourse.

Pension Plan Solvency and Extreme Market Movements: A Regime Switching Approach ‐ Abstract of the Leeds discussion

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