Declining Discount Rates: Evidence from the UK

(UK Performance and Innovation Unit, 2002). Both decommission costs and carbon credits are
naturally sensitive to the use of DDRs and in Table 6 we compare the NPV of investment in
a nuclear power station using our estimated DDRs.¹⁰ The appraisal shows that although the
SS model has significant consequences for the present value of revenues and carbon credits,
the present value of decommissioning and operating costs is also increased considerably. In
this respect, the NPV of nuclear build is affected only marginally when evaluated using DDRs,
although the SS and the RS models increase the NPV of the project by more than 8%.

5 Conclusions

This paper builds on N&P’s econometric approach to determining DDRs and emphasises the
policy relevance of model selection when dealing with lengthy time horizons. Using UK interest
rate data we show that the econometric specification should allow the data generating process
to change over time and that the broad class of state space models is appropriate. The policy
relevance of our procedure is highlighted in the valuation of carbon sequestration the present
value of which is increased by over 200%.

References

[1]Gollier, C. (2002a). Time Horizon and the Discount Rate. Journal of Economic Theory 107
(2), 463-473.

[2]Gollier, C. (2002b). Discounting an Uncertain Future. Journal of Public Economics 85, 149-
166.

[3]HM Treasury, (2003). The Green Book: Appraisal and Evaluation in Central Government:
London: HM Treasury.

[4]Newell, R. and W. Pizer (2003). Discounting the Benefits of Climate Change Mitigation:
How Much do Uncertain Rates Increase Valuations? Journal of Environmental Economics
and Management 46 (1), 52-71.

[5]Pearce, D., B. Groom, C. Hepburn and P. Koundouri (2003). Valuing the Future: Recent
Advances in Social Discounting. World Economics 4 (2), 121-141.

[6]Performance and Innovation Unit (2002). The Energy Review - February.

[7]Weitzman, M. (1998). Why the Far Distant Future Should be Discounted at its Lowest
Possible Rate. Journal of Environmental Economics and Management 36, 201-208.

¹⁰We follow the same cost and price assumptions and time horizons for construction, operation and decommis-
sioning as Pearce et al. (2003).

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