Association for Public Policy Analysis & Management

How will climate risks affect U.S. housing markets? This paper is motivated by two observations: (1) In the United States, both private and public agents exhibit significant heterogeneity in their beliefs about climate risks. (2) From an asset pricing perspective, it is well-known that heterogeneity in beliefs about future fundamentals can lead to inflated prices and ensuing risks (bubbles, excess volatility, etc.). Consequently, this paper asks how climate belief heterogeneity will affect housing market dynamics and the costs of sea-level rise. We provide both theoretical and novel empirical evidence: First, we build a dynamic housing market model with heterogeneity in home types, consumer preferences, and flood risk beliefs. The model incorporates a Bayesian learning mechanism for agents unsure about flood risks. Second, in order to quantify these elements, we implement a door-to-door survey in Rhode Island. The results confirm significant heterogeneity in flood risk beliefs, and that selection into coastal homes is driven by both lower risk perceptions and higher coastal amenity values. Third, we calibrate the model to simulate home prices across belief and flood risk scenarios. Compared to a setting with homogeneous rational expectations, coastal home price devaluations due to increases in flood risks are projected to be 10 times more severe when belief heterogeneity is taken into account. Market volatility similarly increases by an order of magnitude. Studies assuming homogeneous rational expectations may thus substantially underestimate the macroeconomic risks posed by sea-level rise. Given recent proposals to deprioritize flood risk information and funding, public policy has the potential to significantly exacerbate – or mitigate – housing market volatility in the coming years.