Modelling economic decision-making under uncertainty: a comparison of 1
approaches
Abstract
Modelling economic decision-making under uncertainty typically involves
approaches that assume perfect foresight, or that future information is
knowable and awaiting discovery (white-swan problems). By contrast,
grey-swan problems where some information may be known
probabilistically, and other information remains uncertain (no
probability measures), is less commonly modelled in the literature.
Climate change is a classic grey-swan problem that will shape complex
economic, social and environmental decisions for generations to come.
Within the global debate on water scarcity and inequality strategies for
(re)allocating water resources in response to climate change impacts are
of particular concern. Analysts need to be able to inform decision
makers on how to best adapt given uncertain futures. This paper
contrasts the outputs from (re)allocating water resources via expected
value and stochastic state contingent modelling approaches;where both
are specified to represent white- and grey-swan problems. The models
represent how water resources (re)allocate under current climate
settings and two alternative future climate change scenarios: i) a
reduction in total water availability/use, and ii) the increased
occurrence of bad (e.g., drought) events. Expected value models mask
innovation and adaptation reactions by decision-makers in response to
external stimuli (e.g., increased droughts), and under-represent water
(re)allocation outcomes. Conversely, state contingent models more
clearly represent and report decision-maker reactions that can be more
readily interpreted and linked to stimuli including policy
interventions.