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

Author

Listed:
  • Stefano Giglio
  • Matteo Maggiori
  • Johannes Ströbel
  • Andreas Weber

Abstract

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.

Suggested Citation

  • Stefano Giglio & Matteo Maggiori & Johannes Ströbel & Andreas Weber, 2015. "Climate Change and Long-Run Discount Rates: Evidence from Real Estate," CESifo Working Paper Series 5608, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_5608
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    References listed on IDEAS

    as
    1. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters,in: This Time Is Different: Eight Centuries of Financial Folly Princeton University Press.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 1065-1188, November.
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    4. Brent W. Ambrose & Piet Eichholtz & Thies Lindenthal, 2013. "House Prices and Fundamentals: 355 Years of Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(2-3), pages 477-491, March.
    5. Reinhart, Carmen & Rogoff, Kenneth, 2009. "This Time It’s Different: Eight Centuries of Financial Folly-Preface," MPRA Paper 17451, University Library of Munich, Germany.
    6. Martin Lettau & Jessica A. Wachter, 2007. "Why Is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," Journal of Finance, American Finance Association, vol. 62(1), pages 55-92, February.
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    Citations

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    Cited by:

    1. Iverson , Terrence & Karp, Larry, 2017. "Carbon taxes and climate commitment with non-constant time preference," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt3hw6s14v, Department of Agricultural & Resource Economics, UC Berkeley.
    2. Riccardo Colacito & Bridget Hoffmann & Toan Phan, 2016. "Temperature and Growth: A Panel Analysis of the United States," IDB Publications (Working Papers) 7654, Inter-American Development Bank.
    3. Harrison Hong & Frank Weikai Li & Jiangmin Xu, 2016. "Climate Risks and Market Efficiency," NBER Working Papers 22890, National Bureau of Economic Research, Inc.
    4. Gollier, Christian, 2016. "Evaluation of long-dated assets: The role of parameter uncertainty," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 66-83.
    5. Fesselmeyer, Eric & Liu, Haoming & Salvo, Alberto, 2016. "How Do Households Discount over Centuries? Evidence from Singapore's Private Housing Market," IZA Discussion Papers 9862, Institute for the Study of Labor (IZA).
    6. Riccardo Colacito & Bridget Hoffmann & Toan Phan, 2016. "Temperature and Growth: A Panel Analysis of the United States," IDB Publications (Working Papers) 94298, Inter-American Development Bank.
    7. Gollier, Christian, 2017. "Valuation of natural capital under uncertain substitutability," TSE Working Papers 17-813, Toulouse School of Economics (TSE).
    8. Katz, Yuri A., 2017. "Value of the distant future: Model-independent results," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 466(C), pages 269-276.

    More about this item

    Keywords

    environmental economics; declining discount rates; climate change; real estate; cost-benefit analysis; asset pricing;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • R30 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - General

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