Implied CO$_{\textbf{2}}$-Price and Interest Rate of Carbon

Paper: arXiv 2312.13448

Authors: Christian P. Fries

Abstract

By its nature, the so-called social cost of carbon (SCC(t)) will likely not cover the cost induced by climate change (damage cost and abatement cost) if it is used as a CO$_2$-price. It is a marginal price only. We define an implied CO$_2$-price that covers the climate change-induced costs. The price can be interpreted as a \textit{polluter pays principle}. A numerical analysis using a classical DICE model reveals that the cost-implied CO$_2$ price is around 500 $/tCO$_2$, while the corresponding price associated with the SCC is about 50 $/tCO$_2$. In addition, we define the internal rate of return of carbon abatement and calculate it for the classical DICE model. This rate is much higher than the model’s discount rate, which may suggest the advantage of financing abatement by loans.

Complexity vs Empirical Score

• Math Complexity: 5.5/10
• Empirical Rigor: 4.5/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper introduces a novel economic concept by contrasting the social cost of carbon with an implied cost-covering price and an internal rate of return for abatement using the DICE framework. While mathematical modeling is sound, the empirical rigor relies primarily on simulation and calibrated model parameters rather than extensive market data backtesting.

Research Flowchart

  flowchart TD
    A[Research Goal: Define CO2 price covering full climate costs] --> B[Input: DICE Model Data & Climate Cost Equations]
    B --> C[Calculate Standard Social Cost of Carbon vs Implied CO2 Price]
    B --> D[Compute Internal Rate of Return for Carbon Abatement]
    C --> E[Outcome: Implied CO2 Price ~$500/tCO2 vs SCC ~$50/tCO2]
    D --> F[Outcome: Carbon IRR exceeds model discount rate]
    E --> G[Policy Implication: Polluter Pays Principle & Financing Abatement via Loans]
    F --> G