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How likely is a catastrophic event that would substantially reduce the capital stock, GDP, and wealth? How much should society be willing to pay to reduce the probability or impact of a catastrophe? We answer these questions and provide a framework for policy analysis using a general equilibrium model of production, capital accumulation, and household preferences. Calibrating the model to economic and financial data, we estimate the mean arrival rate of shocks and their size distribution, the tax on consumption society would accept to limit the maximum size of a catastrophic shock, and the cost to insure against its impact. (JEL D81, E22, E23, E32, G22, H25, Q54)
Pindyck et al. (Thu,) studied this question.
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