Adaptation Time to Climate-Induced Extreme Events—Impact of Trend, Seasonality, and Interest Rate Stochasticity

Abstract

Climate-induced catastrophes such as bushfires, hurricanes, floods, and storm surges have caused significant damage in many regions. The frequency and severity of these events may further increase with climate change, making adaptation imperative. In this article, we introduce a new modeling framework to analyze regional adaptation to catastrophic risk. Using extreme value theory to model climate risk, we analyze the impact of seasonality and risk aversion on investment decisions. We also analyze the impact of stochastic interest rates on optimal adaptation timing. In a case study of New York City’s flood risk management, we find that neglecting seasonality or risk aversion can underestimate investment values and cause unwarranted adaptation delays. In addition, our findings highlight that allowing for stochastic interest rates can lead to earlier climate change adaptation.