Research Highlights
Is climate change mitigation worth it?
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... people are more willing than previously thought to invest today for the benefit of future generations.
Recent months have seen a lively policy debate surrounding the optimal response to climate change. One important question at the forefront of this debate involves trading off the cost of mitigating greenhouse gas emissions versus the expected long-term benefits of doing so. NYU Stern Assistant Finance Professors Johannes Stroebel and Matteo Maggiori, along with Stefano Giglio of the University of Chicago’s Booth School of Business, have contributed an intriguing analysis that contributes to this discussion.
Because of the difficulty of estimating the present value of savings from avoiding climate disasters that won’t materialize until well into the future, the three authors approached their subject in a novel way: by investigating the pattern of leasehold and freehold pricing for residential housing over very long horizons in the UK and Singapore. This form of property ownership is unique in that it spans many generations, providing a perspective that is otherwise unavailable.
In “Very Long-Run Discount Rates,” the authors observe that there is little direct empirical evidence on how households discount payments over very long horizons. They reasoned that because leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities ranging from 99 to 999 years, while freeholds are perpetual, the difference between leasehold and freehold values would reflect the present value of perpetual rental income starting at the expiration of the leasehold. It could thus provide valuable information about very long-run discount rates – far beyond the usual horizon of 20 to 30 years spanned by bond markets – that could be useful in the climate change policy debate.
They based their analysis on property sales in the UK from 2004 to 2013 and in Singapore from 1995 to 2013, finding that leaseholds with 80 to 99 years remaining are valued at around 15 percent less than otherwise identical freeholds, while leaseholds with maturities of 100 to 124 years are discounted by around 10 percent compared with similar freeholds. “In other words,” Stroebel says, “households attach substantial present value to owning the housing asset in 100 or 125 years.”
From these estimates the authors backed out the implied discount rate for housing cash flows occurring in the very distant future, finding an annual discount rate of around 2.6 percent for both the UK and Singapore – a rate lower than most economic theory would suggest. Thus, they write, people “are more willing than previously thought to invest today for the benefit of future generations."
Says Stroebel: “Many of the potential costs of climate change will materialize over extremely long horizons; however, we had relatively little information about time and risk preferences of households over those horizons. While the precise discount rates for climate change investment will depend on the risk properties of that investment, we felt our estimates could provide some guidance on the relevant discount rates important to this policy debate.
Because of the difficulty of estimating the present value of savings from avoiding climate disasters that won’t materialize until well into the future, the three authors approached their subject in a novel way: by investigating the pattern of leasehold and freehold pricing for residential housing over very long horizons in the UK and Singapore. This form of property ownership is unique in that it spans many generations, providing a perspective that is otherwise unavailable.
In “Very Long-Run Discount Rates,” the authors observe that there is little direct empirical evidence on how households discount payments over very long horizons. They reasoned that because leaseholds are temporary, pre-paid, and tradable ownership contracts with maturities ranging from 99 to 999 years, while freeholds are perpetual, the difference between leasehold and freehold values would reflect the present value of perpetual rental income starting at the expiration of the leasehold. It could thus provide valuable information about very long-run discount rates – far beyond the usual horizon of 20 to 30 years spanned by bond markets – that could be useful in the climate change policy debate.
They based their analysis on property sales in the UK from 2004 to 2013 and in Singapore from 1995 to 2013, finding that leaseholds with 80 to 99 years remaining are valued at around 15 percent less than otherwise identical freeholds, while leaseholds with maturities of 100 to 124 years are discounted by around 10 percent compared with similar freeholds. “In other words,” Stroebel says, “households attach substantial present value to owning the housing asset in 100 or 125 years.”
From these estimates the authors backed out the implied discount rate for housing cash flows occurring in the very distant future, finding an annual discount rate of around 2.6 percent for both the UK and Singapore – a rate lower than most economic theory would suggest. Thus, they write, people “are more willing than previously thought to invest today for the benefit of future generations."
Says Stroebel: “Many of the potential costs of climate change will materialize over extremely long horizons; however, we had relatively little information about time and risk preferences of households over those horizons. While the precise discount rates for climate change investment will depend on the risk properties of that investment, we felt our estimates could provide some guidance on the relevant discount rates important to this policy debate.