Considering Uncertainty in Project Appraisal
Theroy and case studies
Biofuels in the European Context: Facts and Uncertainties
A review, including acost benefit analysis, of the European Commissions proposed biofuels policy
Discounting in Cost-Benefit Analysis
There is much disagreement about the discount rate. The prescriptive approach derives the discount rate from utility functions, growth models and ethical considerations. The descriptive approach stresses the opportunity cost of capital, but struggles to define which market rates to average. Both use social (shadow) discount rates to compensate for capital market distortions. Others propose discount rates declining through time. This paper argues that it is wrong to use shadow discount rates because they cannot ensure the efficient allocation of public funds nor correct for capital market distortions. Instead the marginal cost of public sector funds should be used for discounting and the shadow price of capital should be used to adjust for distortions. No other discount rate will lead to correct cost-benefit analysis results. This paper argues that discounting and inter-temporal distribution weighting are not equivalent, and that the former is required for correct cost-benefit analysis results. It argues further that discount rates should not be declining; and that the requirements for robustness of conclusions and the partial equilibrium nature of cost-benefit analysis limit the scope of its applicability.
Comment on Burgess and Zerbe's “Appropriate Discounting for Benefit-Cost Analysis
This is a comment on a paper by David F. Burgess and Richard O. Zerbe. It derives a different set of conclusions than the cited authors do from the customary premises underlying benefit-cost analysis. It concludes that capital should be shadow priced, and that the appropriate discount rate to use in benefit-cost analysis is the interest rate of the capital market to which the public sector has access. It proposes that a plausible source of the great divergence in approaches to discounting stems from different answers being given to the question of whether present day consumption has a future consumption opportunity cost.
The Hungarian electrical energy sector: an agent based model
This paper provides a brief description of an agent based model built for the Hungarian Electrical Energy sector in 2005. The paper describes the background of the sector, the rationale for building the model, and its principal results. The paper presents the structure of a model, its outputs, the agents modeled, the method of solving the model, and discusses the problems of convergence encoun-tered. It describes the computational platform used and presents conclusions re-garding the benefits of the approach taken.
The “Weitzman-Gollier puzzle” is not a paradox but a mistake, and it is most likely moot
The “Weitzman-Gollier puzzle” refers to the observation that, when interest rates are uncertain, the expected values of discount factors and compound factors for a pair of present and future values yield different certainty-equivalent discount rates, which are either decreasing or increasing as a function of time, and either tend to the lowest or to the highest possible interest rate. There were many attempts to both resolve this apparent paradox and to justify the conclusion that discount rates should be declining in the long term, but none explained why the certainty-equivalents diverge. The cause of the divergence was found to be Weitzman’s incorrect formulation of the expected discount factor in his 1998 article. Correcting for this, the puzzle disappears, and Weitzman’s model shows that discount rates should be increasing in the long term. However, the entire question is moot, as it depends on annual interest rates displaying nearly perfect autocorrelation.
Governments Should Not Use Declining Discount Rates in Project Analysis.
When Should the Distant Future not be Discounted at Increasing Discount Rates?