Very Long-Run Discount Rates
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
Harvard University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
New York University (NYU)
May 8, 2014
Fama-Miller Working Paper
We provide direct estimates of how agents trade off immediate costs and uncertain future benefits that occur in the very long run, 100 or more years away. We exploit a unique feature of housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities between 99 and 999 years, while freeholds are perpetual ownership contracts. The difference between leasehold and freehold prices reflects the present value of perpetual rental income starting at leasehold expiry, and is thus informative about very long-run discount rates. We estimate the price discounts for varying leasehold maturities compared to freeholds and extremely long-run leaseholds via hedonic regressions using proprietary datasets of the universe of transactions in each country. Agents discount very long-run cash flows at low rates, assigning high present values to cash flows hundreds of years in the future. For example, 100-year leaseholds are valued at more than 10% less than otherwise identical freeholds, implying discount rates below 2.6% for 100-year claims. Given the riskiness of rents, this suggests that both long-run risk-free discount rates and long-run risk premia are low. We show how the estimated very long-run discount rates are informative for climate change policy.
Number of Pages in PDF File: 157
Keywords: Cost-Benefit Analysis, Asset Pricing, Environmental Economics, Climate Change, Real Estate, House Prices Risk and Return
JEL Classification: G11, G12, R30working papers series
Date posted: October 28, 2013 ; Last revised: September 12, 2014
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