Working Paper: NBER ID: w21767
Authors: Stefano Giglio; Matteo Maggiori; Johannes Stroebel; 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 disaster-risk 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.
Keywords: Climate Change; Discount Rates; Real Estate; Investment
JEL Codes: G11; G12; R30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| discount rate (E43) | optimal investment to mitigate climate change (Q54) |
| horizon over which benefits accrue (J32) | appropriate discount rate (H43) |
| riskiness of the investment (G11) | appropriate discount rate (H43) |
| term structure of discount rates for real estate (E43) | appropriate discount rate for climate change investments (H43) |
| average rates of return from traded assets (G12) | misleading evaluation of climate change investments (Q54) |
| discount rates for climate change abatement investments (H43) | bounded above by estimated term structure for risky housing (R31) |
| empirical findings (C90) | challenge previously suggested discount rates (H43) |