Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/123242 
Year of Publication: 
2015
Series/Report no.: 
CESifo Working Paper No. 5608
Publisher: 
Center for Economic Studies and ifo Institute (CESifo), Munich
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 disasterrisk 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.
Subjects: 
environmental economics
declining discount rates
climate change
real estate
cost-benefit analysis
asset pricing
JEL: 
G11
G12
R30
Document Type: 
Working Paper
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