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Working Papers

January 2023, No. 23-01R (Revised May 2024)

Leveraging the Disagreement on Climate Change: Theory and Evidence

Laura Bakkensen, Toan Phan and Russell Wong

We develop a credit model where agents disagree on when long-run disaster risk, such as flooding from sea level rise (SLR), will damage collateral assets. Unlike existing models, ours predicts that pessimistic agents are more likely to leverage risky asset purchases, and prefer debt contracts with longer maturities. Intuitively, anticipating high risk of collateral damage, pessimists value the implicit insurance in the option to default. Using high-resolution SLR projections and comprehensive coastal real estate and mortgage data, we find robust evidence of these predictions. We also analyze how securitization and other policies affect the mortgage market's SLR exposure.


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