Sea Level Rise and Optimal Flood Protection in an Uncertain World - With Ton van den Bremer and Rick van der Ploeg (link to working paper)
We analyse optimal investment in one of the most important forms of climate adaptation: flood protection. Investments to build and heighten dykes and surge barriers involve considerable adjustment costs, so that their construction locks in the level of flood protection for some time. Investment decisions must take into account both economic and sea level rise uncertainty over a horizon of several decades, where the latter is to a large extent driven by global warming. We put forward a tractable macro-finance DSGE model that includes flood risk. We obtain solutions for optimal flood protection as a function of these uncertainties, costs, and preferences regarding impatience, risk aversion and intertemporal substitution. Sea level rise uncertainty always leads to more flood protection. Economic uncertainty leads to less (more) protection if the elasticity of substitution is greater (less) than one. We illustrate our results with a calibrated case study for the Netherlands.
Climate Scepticism in the Market for Flood-Exposed Housing - With Sevim Dinlemez (link to working paper)
We study the welfare effects of irrational climate beliefs in the housing market. In an established macroeconomic housing model, we posit two types of households: one type which holds rational beliefs over future flood risk and another type which underestimates flood risk. Climate scepticism in the housing market increases the aggregate welfare cost of rising flood risk, which becomes concentrated among households with mistaken beliefs. Climate sceptics overinvest in coastal housing and save too little in anticipation of flood losses, which reduces their expected welfare. Their behaviour also inflates coastal house prices in general equilibrium, which leads to allocative inefficiency and excessive building in coastal areas. Our quantitative model, calibrated to the United States, shows how climate scepticism affects welfare along the income and wealth distribution, and how it depends on housing-market features including government regulation.