Loss Aversion in International Environmental Agreements

We study the impact of loss-aversion and the threat of critical damages from insufficient pollutant abatement, which we jointly call threshold concerns, on the outcome of international environmental agreements. We aim to understand whether concerns for a critical level of damages induce cooperation among countries faced with the well-known free-riding problem, and yield sufficient emission reductions to avoid exceeding the threshold. Specifically, we focus on loss-averse countries negotiating under the threat of either high or low environmental damages. Under symmetry, when countries display identical degrees of threshold concern, we show that such beliefs have a positive effect on reducing the emission levels of both signatories to the treaty and non-signatories, leading to weakly larger coalitions of signatories than in the absence of reference dependence. We then introduce asymmetry, by allowing countries to differ in the degree of concern about the damages. We show that stable coalitions are mostly formed by the countries with higher threshold concerns. When enough countries exhibit standard preferences, the coalition size may diminish, regardless of the degree of concern by the others.