The dismal theorem in a general equilibrium climate-economy model

We show that Weitzman (2009)’s dismal theorem resurfaces naturally within a dynamic asset pricing framework with temperature-related disaster risk. If the climate disaster loss distribution is sufficiently fat-tailed, the risk-adjusted expected loss term diverges. Under unit elasticity of intertemporal substitution (EIS), this causes the social cost of carbon (SCC) to explode and the underlying optimization problem to have no finite solution so that the dynamic general equilibrium analogue of the dismal theorem applies. We show that, if the risk of climate tipping increases with temperature, the fat tail becomes endogenous and the dismal result is more likely to be activated at higher temperatures.