Changes in Implicit Flood Risk Premiums: Empirical Evidence from the Housing Market

Abstract:     
Hedonic valuation models have shown that sales prices can capitalize property risk factors, such as flood zone; properties facing lower risk sell at a premium, all else being equal. Previous research has indicated that price differentials reflecting risk of flooding become much larger in the wake of a storm. We re-examine these findings for Pitt County, NC using multiple storm events within a difference-in-differences framework, and we compare flood zone price differentials for a more recent sample of property sales. Prior to Hurricane Fran in 1996, we detect no market risk premium for presence in a flood zone, but we find significant price differentials after major flooding events, amounting to a 5.7% decrease after Hurricane Fran and 8.8% decrease after Hurricane Floyd. Results from a separate model that examines more recent data covering a period without significant storm-related flood impacts indicate a significant risk premium ranging between 6.0% and 20.2% for homes sold in the flood zone, but this effect is diminishing over time, essentially disappearing about 5 or 6 years after Hurricane Floyd. The lack of a persistent effect suggests that buyers’ and sellers’ risk perceptions may change with the prevalence of hazard events and that homebuyers are unaware of flood risks and insurance requirements when bidding on properties.

Number of Pages in PDF File: 45

Keywords: flood hazards, hedonic prices, availability bias, spatial regression, risk premiums

JEL Classification: D12, G22, Q24, R21

working papers series