Friday, May 23, 2014

Asset Markets and Heterogeneous Beliefs: Why Don't Climate Change Deniers Purchase All Miami Flood Prone Real Estate?

A turtle carries its shell on its back.  When it moves, it brings its "house" with it.    Imagine if coastal residents could at low cost move their homes to "higher ground" when sea level rise takes place.  In this case, the owners of such homes would lose the value of the land but not their structure.  This unbundling of a home (which is usually the structure and the land) would reduce the cost of climate change adaptation.   In the real world it is costly to physically move real estate structures.  An alternative to moving capital to higher ground is to allocate it to those who are willing to bear the risk.

If all buyers and sellers of real estate are risk neutral, the climate change deniers should be purchasing up coastal land from the average person.  Why?  The climate change deniers deny that significant sea level rise will take place and thus they don't believe a word of doom and gloom articles about Miami such as this one in Rolling Stone.  In this case, standard economic logic predicts that disagreement about future probabilities of events generates gains from trade.  Those who fear climate change risk should be willing to sell at a discount and those who scoff at this risk should be willing to pay this price and enjoy the "good deal" for the beach front real estate.

I recognize that part of the answer is that those who might fear climate change may view Miami's coast to be so beautiful that this amenity's value outweighs the current expected flood risk.  But, there are many coastal locations around the nation that might be better able to face sea level rise.  A person who holds the belief that SLR is a real challenge and owns coastal Miami property could sell and move to this alternative location that has bundled access to the coast and greater personal safety.   If Miami were the only beautiful coastal location then there wouldn't be a puzzle here.  But, there are thousands of miles of coast line.

UPDATE:   Apparently great minds think alike!  Joe Romm just independently published a very similar piece!