Climate Change and Long-Run Discount Rates: Evidence from Real Estate

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. The optimal investment to mitigate climate change crucially depends on the discount rate used to evaluate the investment's uncertain future benefits. The appropriate discount rate is a function of the horizon over which these benefits accrue and the riskiness of the investment. In this paper, we estimate the term structure of discount rates for an important risky asset class, real estate, up to the very long horizons relevant for investments in climate change abatement. We show that this term structure is steeply downward-sloping, reaching 2.6% at horizons beyond 100 years. We explore the implications of these new data within both a general asset pricing framework that decomposes risks and returns by horizon and a structural model calibrated to match a variety of asset classes. Our analysis demonstrates that applying average rates of return that are observed for traded assets to investments in climate change abatement is misleading. We also show that the discount rates for investments in climate change abatement that reduce aggregate risk, as in disasterrisk models, are bounded above by our estimated term structure for risky housing, and should be below 2.6% for long-run benefits. This upper bound rules out many discount rates suggested in the literature and used by policymakers. Our framework also distinguishes between the various mechanisms the environmental literature has proposed for generating downward-sloping discount rates. Terms of use: Documents inJEL-Codes: G110, G120, R300.

Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

“…Third, by using daily hurricane forecasts from NOAA, this paper adds to recent climate finance research that analyzes how NOAA forecasts are reflected in asset prices. Drawing mixed conclusions, several papers (see Bernstein, Gustafson, and Lewis (2018); Giglio, Maggiori, Rao, Stroebel, and Weber (2018); Murfin and Spiegel (2019)) use NOAA sea level rise predictions to examine whether residential real estate prices reflect sea level rise risks. Our use of NOAA forecasts is substantially different, because for hurricanes we can observe multiple isolated events from inception to resolution, whereas NOAA's forecasts for sea level rise are long-term and cannot yet be compared to realizations.…”

Climate risks and market efficiency

“…Bansal, Kiku, and Ochoa (2014) argue that long-run climate risks as captured by temperature are priced into the market. Daniel, Litterman, and Wagner (2015) and Giglio, Maggiori, Stroebel, and Weber (2015) show how stock and real estate markets might help guide government policies assuming markets efficiently incorporate such climate risks. Our analysis suggests that such climate risk information, at least when it comes to natural disasters, is not efficiently priced.…”

The Rate of Return on Real Estate: Long-Run Micro-Level Evidence

“…Real estate has delivered attractive investment returns over the past few decades (e.g., Favilukis et al (2017), Ghent et al (2018), Giglio et al (2018)). 1 Yet, we possess only a limited understanding of its longer-term track record, especially when compared to our knowledge of historical bond and equity returns (e.g., Jorion and Goetzmann (1999), Dimson et al (2002)).…”

“…The latter two 1 Favilukis et al (2017) estimate average real returns to U.S. housing of 9-10%, before maintenance costs and property taxes, over the 1976-2012 period. For U.K. housing, Giglio et al (2018) document average real net returns of about 7% over the 1988-2016 period. Ghent et al (2018) report average nominal returns to privately held commercial real estate of 9-12% for di˙erent periods since the 1970s.…”