Discussion Paper Series No. 645 Global Environmental Risks

We study the risks associated with the prospect of global climate change, and review the mechanisms available for their efficient allocation in market economies. Risks in this field are typically unknown and often unknowable ex ante; their probabilities are endogenous and determined by economic ac-tions; they have both collective and individual components, and they are about processes that may be irreversible. The theory of how to allocate such risks is still being developed, but a certain amount is known about insurance with unknown risks and about un-certainty and irreversibility. We indicate what is known and set out its policy implications, and provide a challenging but realistic research agenda. We show that existing theories provide a framework for evaluating policies for mitigating global climate change. How much a society should pay to mitigate global change depends on a society's discount rate, degree of risk aversion, and assessment of the relevant probabilities. As these may differ from societ