Abstract

One of the central challenges facing International Environmental  Agreements (IEAs) is the persistent lack of incentives for countries to make  ambitious climate pledges and to follow through on their implementation,  largely due to the temptation to free-ride on the efforts of others. To address  this, we propose a novel incentive mechanism that links participation in a  climate mitigation agreement to enrolment in a risk-sharing (insurance) scheme,  called climate insurance-mitigation agreement (CIMA). Under this mechanism, all  countries that join the mitigation agreement contribute to a common pool, which  is then used to compensate members for climate-related losses. Crucially, the  compensation each country receives is linked to its fulfilment of pledged
mitigation actions.  We model a climate mitigation game in which each country faces random climate  losses, with distributions shaped by the overall level of climate change. We  employ convex risk measure theory to assess the cost of climate risk, and later  to determine suitable risk sharing contracts. As expected, the non cooperative  equilibrium  of Nash type (NE)  is suboptimal. We introduce CIMA and  characterize conditions under which they ensure the stability and effectiveness  (compliance) of the grand coalition. We show numerically that, consistently  across various parameter configurations, including a real-world calibration,  there exist stable and effective CIMA which significantly improve global  mitigation efforts and global welfare with respect to the NC. We show that  these results are achieved thanks to the benefits of risk sharing.

Practical information