Giglio, Maggiori, and Stroebel (2015): Very Long-Run Discount Rates

Why this paper is on the syllabus

This paper anchors the discounting material because it speaks directly to the central difficulty in climate policy: how to value benefits and damages that arrive far in the future. A large share of climate policy asks society to pay costs today in exchange for benefits that arrive 50, 100, or 200 years from now. Whether those future benefits look first-order or negligible depends heavily on the discount rate applied to them, and at very long horizons there is very little market evidence that pins that rate down.

That is where Giglio, Maggiori, and Stroebel make progress. They exploit an unusual institutional feature of residential property markets in the United Kingdom and Singapore to recover the implicit market valuation of cash flows that begin more than a century in the future. The resulting estimates are among the most direct evidence we have on how markets price ownership claims at horizons long enough to be policy-relevant for climate.

The question

The paper asks a single, sharply defined question: at what rate do housing markets discount cash flows that begin in the very distant future?

The question is abstract in phrasing but first-order in climate economics. If market behavior implies that a dollar 100 years from now carries almost no present value, then long-run climate damages enter present-value calculations with very little weight, and stringent mitigation today becomes hard to justify on cost-benefit grounds. If market behavior instead implies that century-ahead cash flows still carry meaningful weight, then far-future climate damages matter substantially in current policy analysis and cost-benefit work.

The institutional setting

The identification strategy rests on a specific feature of property ownership in England, Wales, and Singapore. In these markets, residential property is sold either as a freehold or as a leasehold.

A freehold conveys effectively perpetual ownership. A leasehold conveys ownership for a finite number of years, commonly 99, 125, 250, or even 999 years, after which ownership reverts to the freeholder. A leasehold owner therefore receives the flow of housing services and the resale value only until the lease expires, while a freehold owner also owns the stream of housing services beyond that date.

That contractual difference is exactly what makes the setting useful for measuring very long-run discount rates. If a 100-year leasehold sells for less than an otherwise identical freehold on the same property type and in the same local market, the price gap reflects the present value of the housing-service stream that begins only after year 100. In other words, the cross-section of lease lengths reveals how the market prices cash flows at horizons that standard bond markets do not reach.

What the authors do

The authors assemble transaction-level data on the universe of residential property sales in England and Wales from 2004 to 2013 and in Singapore from 1995 to 2013. For each transaction, they observe the sale price, the contract type, the remaining lease length, and a rich set of property characteristics including location, size, and structural attributes.

The empirical strategy is hedonic. The authors compare prices across otherwise-similar properties that differ in remaining lease length, absorbing variation in location and structure with fine-grained controls and fixed effects. They do not compare small apartments in weak markets to mansions in strong markets; they compare properties that are close substitutes in location and structure and ask how price varies with remaining lease length.

Several features of the design are important for credibility. The authors include detailed controls for structure and location, exploit within-area comparisons at a fine geographic scale, and show that the same patterns appear in two institutionally distinct countries. They also study a broad range of lease maturities. That is essential, because it is the full schedule of discounts across 50-year, 100-year, 150-year, and longer leases that identifies the term structure of long-run discount rates rather than a single point estimate.

How the strategy works

The key economic object is the present value of the rent stream that begins after the lease expires. A freehold can be decomposed into two assets bundled together:

1. the right to the housing-service flow until year \(T\),
2. the right to the housing-service flow from year \(T\) onward.

A leasehold with \(T\) years remaining conveys only the first component. The freehold-leasehold price gap therefore isolates the present value of the second component, which is a pure long-horizon cash flow.

That logic is informative because the relevant cash flow starts far in the future. For a 100-year leasehold, the missing rent stream begins only after year 100. The observed freehold-leasehold price gap therefore reveals how the market discounts a claim whose payoffs all arrive beyond a century. Standard government and corporate bonds, with maturities in the range of years to a few decades, do not let researchers isolate discounting at these horizons. The housing market creates variation in effective maturity that reaches 80 to 250 years and beyond.

Main findings

The headline result is that very long-run discount rates are low, and that markets do not treat distant future cash flows as irrelevant.

Quantitatively, 100-year leaseholds trade at roughly 10 to 15 percent discounts relative to otherwise similar freeholds. For shorter remaining maturities of 50 to 70 years, the discount grows to around 30 percent. Translated into implied discount rates, these gaps imply total long-run discount rates at horizons of 100 years or more on the order of 2 percent annually, and below approximately 2.6 percent. These rates are substantially lower than the 5 to 6 percent figures that are sometimes invoked in applied cost-benefit work on climate policy.

The evidence is inconsistent with a single, constant, high discount rate. Housing as an asset class earns relatively high average returns, and yet the market assigns meaningful value to cash flows far in the future. A constant high discount rate cannot reconcile those two facts. The estimates instead point toward a downward-sloping term structure, in which discount rates are higher at short and intermediate horizons and fall at very long horizons. The authors refer to this tension as a long-run valuation puzzle.

Why the result matters

The implications for climate policy are first-order. If century-ahead damages are discounted at 6 percent annually, they are close to zero in present-value terms, and stringent mitigation today is hard to justify from a narrow cost-benefit perspective. If long-run discount rates are closer to 2 percent, as the market evidence suggests, then far-future climate damages retain substantial weight, and the optimal scale of near-term mitigation rises accordingly.

It is important to be careful about the interpretation. The paper estimates how markets price private cash flows, not how a social planner should discount intergenerational welfare. It does not resolve debates over pure rates of time preference, intergenerational equity, or ethical parameter choices in integrated assessment models. What it does do is discipline one common claim in climate-policy debates: the assertion that markets obviously discount far-future cash flows at very high rates is inconsistent with the housing-market evidence. The far future is not priced at zero.

The paper is also consequential outside climate economics. It provides asset-pricing theory with a new moment to match. Standard consumption-based and long-run-risk models often struggle to generate both high average equity and housing returns and low discount rates on very distant cash flows. The evidence is therefore useful both as a policy input and as a test for asset-pricing theory.

What to focus on when you read

On a first pass, keep four things in mind.

First, understand the asset being priced. A freehold is a claim on the rent stream forever. A leasehold is a claim only until the lease expires.

Second, understand why the price gap is informative. The difference between freehold and leasehold prices is the market value of the rent stream that begins only after expiry, which is a pure long-horizon cash flow.

Third, focus on the headline magnitudes and their implications. A 100-year leasehold discount of 10 to 15 percent is much larger than a high constant discount rate would predict, and it implies long-run discount rates around 2 percent.

Fourth, separate the positive claim from the normative one. The paper tells us how housing markets price distant cash flows. It does not, by itself, tell us how governments should discount intergenerational welfare in social cost-benefit analysis.

Terms to know

• Discount rate: the rate used to convert future dollars into present-value terms.
• Present value: the value today of a cash flow or stream of cash flows that arrives in the future.
• Freehold: perpetual ownership of a property.
• Leasehold: ownership of a property for a fixed number of years, after which ownership reverts to the freeholder.
• Term structure of discount rates: how the discount rate applied to a cash flow varies with the horizon at which that cash flow arrives.
• Long-run valuation puzzle: the tension between relatively high average asset returns and the relatively low discount rates implied by market prices on very distant cash flows.