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

123 Pages Posted: 5 Aug 2015 Last revised: 9 Mar 2018

See all articles by Stefano Giglio

Stefano Giglio

Yale School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Matteo Maggiori

Harvard University; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Krishna Rao

Stanford University

Johannes Stroebel

New York University (NYU); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Andreas Weber

New York University (NYU) - Leonard N. Stern School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: March 5, 2018

Abstract

We explore what private market data can tell us about the appropriate discount rates for valuing investments in climate change abatement. We estimate the term structure of discount rates for real estate up to the very long horizons relevant for investments in climate change abatement. The housing term structure is downward-sloping, reaching 2.6% at horizons beyond 100 years. We also show that real estate is exposed to both consumption risk and climate risk. We explore the implications of these new data using a tractable asset pricing model that incorporates important features of climate change. Climate change is modeled as a rare catastrophic event, the probability of which increases with economic growth. Economic activity partially mean reverts following a climate disaster, capturing the ability of the economy to adapt. As a result, short-run cash flows are more exposed to climate risk than long-run cash flows, allowing us to match the observed housing term structure. The model and data provide simple yet powerful guidance for appropriate discount rates for investments that hedge climate disaster risk. The term structure of these discount rates is upward-sloping but bounded above by the risk-free rate. For extremely far horizons at which we do not observe the risk-free rate, the estimated long-run discount rates for housing (a risky asset) provide an upper bound that becomes tighter with maturity. This suggests that the appropriate discount rates for investments in climate change abatement are low at all horizons, substantially below those conventionally used for valuing these investments and for determining the social cost of carbon.

Keywords: Climate Change, Discounting, Cost-Benefit Analysis, Real Estate

JEL Classification: G11, G12, R30

Suggested Citation

Giglio, Stefano and Maggiori, Matteo and Rao, Krishna and Stroebel, Johannes and Weber, Andreas, Climate Change and Long-Run Discount Rates: Evidence from Real Estate (March 5, 2018). Chicago Booth Research Paper No. 17-22. Available at SSRN: https://ssrn.com/abstract=2639748 or http://dx.doi.org/10.2139/ssrn.2639748

Stefano Giglio

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Matteo Maggiori

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Krishna Rao

Stanford University ( email )

Stanford, CA 94305
United States

Johannes Stroebel (Contact Author)

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
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New York, NY 10003-711
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Andreas Weber

New York University (NYU) - Leonard N. Stern School of Business ( email )

Suite 9-160
New York, NY
United States

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