Working paper

The cost-efficiency carbon pricing puzzle

Christian Gollier


Any global temperature target can be translated into an intertemporal carbon budget and its associated cost-efficient carbon price schedule. Following Hotelling’s rule, the growth rate of this price should be equal to the interest rate. It is therefore a puzzle that cost-efficiency IAM models yield carbon prices that increase at an average real growth rate around 7% per year. This carbon pricing puzzle suggests that their abatement trajectories are not intertemporally optimized. Using an intertemporal asset pricing approach, I show that the uncertainties surrounding economic growth and future abatement technologies can partially solve this puzzle. I calibrate a simple two-period version of the model by introducing infrequent macroeconomic catastrophes à la Barro in order to fit the model with observed assets pricing in the economy. I show that marginal abatement costs and aggregate consumption are positively correlated, implying a positive carbon risk premium and an efficient growth rate of expected carbon prices larger than the interest rate. From this numerical exercise, I recommend a growth rate of expected carbon price around 3.75% per year (plus inflation). This means that most cost-efficient climate models largely underestimate the efficient carbon price in the short run. I also show that the rigid carbon budget approach to cost-efficiency carbon pricing implies a large uncertainty surrounding the future carbon prices that support this constraint. Green investors are compensated for this risk by a large risk premium embedded in the growth rate of expected carbon prices.


Carbon budget; Hotelling’s rule; consumption-based CAPM; climate finance.;

JEL codes

  • D81: Criteria for Decision-Making under Risk and Uncertainty
  • G12: Asset Pricing • Trading Volume • Bond Interest Rates
  • Q54: Climate • Natural Disasters • Global Warming


Christian Gollier, The cost-efficiency carbon pricing puzzle, TSE Working Paper, n. 18-952, September 2018, revised April 2019.

See also

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TSE Working Paper, n. 18-952, September 2018, revised April 2019