Discount Rate Selection for Investments in Climate Change Adaptation and Flood Risk Reduction Projects

Abstract

The selection of an appropriate discount rate is a critical yet often neglected aspect of valuing flood protection and climate adaptation projects. We examine current discounting practices in flood risk management and climate adaptation literature and compare these practices with a proposed fair market value (FMV) discounting approach, in which we discount project cash flows based on their levels of systematic market risk, consistent with practice in the private sector. Using publicly available data, we demonstrate minimal correlation between flood risk–related cash flows and overall market returns, suggesting flooding-related cash flows are most appropriately discounted near the risk-free rate. We consider the example of a proposed storm surge barrier in Boston Harbor and compare prevailing public-sector discounting approaches with this FMV approach. Our results suggest prevailing discounting approaches systematically undervalue flood risk reduction benefits and climate adaptation investments relative to the private-sector valuation implied via the FMV approach.