Browsing by Author "Pursimo, Juho"

Public investment decisions are important firstly because the tax-payer’s money should be wisely spent, secondly since the government can use its large market share to potentially steer the economy towards goals such as sustainability, and finally because questions of equality can be addressed in public investments. Rational investment decisions should aim to maximise societal welfare, and this can be best achieved in a second best world by using Cost-Benefit Analysis. The choice of a Social Discount Rate to use in Cost-Benefit Analysis has long been a topic in economics. The most used choice rule for the discount rate is the Ramsey equation, which is derived formally in the thesis. To account for uncertainty, a social risk premium, instead of certainty equivalents is proposed to be used in Cost-Benefit Analysis. An expression for the risk premium is formally derived in the Ramsey equation. To examine the need for a risk premium in the Social Discount Rate, the Arrow-Lind theorem is first derived to show, that by risk pooling the public investor can forgo the risk premium. Then, two extensions are integrated to the basic model, wherein first, the effects of an environmental externality, introduced as a ’public bad’, and second, the effects of varying degrees of benefit rivalry under different risk aversion profiles, are examined. The Arrow-Lind theorem is shown to hold in the ’public bad’ case, if Hicks-Kaldor compensations were actually carried out. In the second case, the theorem is shown to hold, even with private project benefits, if individuals’ relative risk aversion and relative prudence are low enough. If the society’s risk aversion profiles can be adequately estimated and they fulfil the criteria defined in the thesis, then the use of a risk premium in the discount rate can be justifiably given up. Finally, the thesis concludes, that different choice rules for the Social Discount Rate should be used based on the individual characteristics of the investment under consideration.