Implications of a Lowered Damage Trajectory for Mitigation in a Continuous-Time Stochastic Model

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. This paper provides counterexamples to the idea that mitigation of greenhouse gases causing climate change, and adaptation to climate change, are always and everywhere substitutes. The author considers optimal policy for mitigating greenhouse gas emissions when climate damages follow a geometric Brownian motion process with positive drift, and the trajectory for damages can be down-shifted by adaptive activities, focusing on two main cases: 1) damages are reduced proportionately by adaptation for any given climate impact (" reactive adaptation "); and 2) the growth path for climate damages This paper is a product of the Environment and Energy Team, Development Research Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at is down-shifted (" anticipatory adaptation "). In this model mitigation is a lumpy one-off decision. Policy to reduce damages for given emissions is continuous in case 1, but may be lumpy in case 2, and reduces both expectation and variance of damages. Lower expected damages promote mitigation, and reduced variance discourages it (as the option value of waiting is reduced). In case 1, the last effect may dominate. Mitigation then increases when damages are dampened: mitigation and adaptation are complements. In case 2, mitigation and adaptation are always substitutes. for helpful comments to previous versions. The views expressed in this paper are those of the author and not necessarily those of the World Bank, its management, Executive Directors or member countries.