EXCESSIVE ENVIRONMENTAL RISKS - AN INTERGENERATIONAL MARKET FAILURE

This paper cautions against the belief that markets work efficiently i n transmitting across generations the right signals for investment dec isions under risk. Overlapping-generation models are used to show that the incompleteness of intergenerational insurance markets constitutes a market failure that leads to inefficient intergenerational investme nt decisions under risk. Early generations over-diversify if they face risks that are larger than those of the following generation and coul d, therefore, be shared with them. On the other hand, if risks are inc reasing from generation to generation, the current generation would un der-insure against those risks. Since the direction of the inefficienc y depends on the nature of the risk assumed, the policy implications d epend on the empirical assessment of the risks that current and future generations are facing. This paper provides applications of the gener al result to environmental problems such as inefficiently low protecti on against global warming, the excessive reduction of biodiversity, an d inefficient depletion of a natural resource.