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 Optimism in the Market for Coastal Housing - With Sevim Dinlemez
We study the economic implications of irrational climate beliefs in the housing market. In an established macroeconomic model of the housing market, we posit two types of households: one type which holds rational beliefs over future flood risk and another type which underestimates flood risk. In keeping with empirical evidence, we propose that repeated flood events eventually cause the disappearance of optimistic beliefs. We find that optimistic beliefs driven by climate scepticism encourage overinvestment in flood-prone areas. The loss of housing capital induced by floods can be decomposed in three channels: (i) the physical destruction; (ii) the revision of beliefs; and (iii) the market disruption from owners' wealth losses. Our macroeconomic model allows us to provide realistic estimates of price corrections and to illustrate the distributional and welfare consequences.