Capitalization of flood insurance and risk perceptions in housing prices: An empirical agent-based model approach

Federally regulated or insured lenders in the United States are mandated to require flood insurance on properties that are in areas at high risk of flooding. Despite the existence of this mandatory flood insurance requirement, take-up rates for flood insurance have been low and the federal government’s exposure to uninsured property losses from flooding remains substantial. This paper aims to quantitatively explore how a scenario of complete insurance uptake, under various levels of risk perception, affects the value of properties in the 100-year and 500-year flood zone. In the pursuit of this goal we pose two research questions: (1) How does the housing market endogenously change with the introduction of a hypothetical full insurance uptake policy that affects households’ budget constraints? (2) How do flood risk perceptions of individual homeowners affect capitalized flood risks, in the absence or presence of the full insurance uptake? Specifically, we assess whether the flood insurance has a profound effect on housing values, whether this effect differs across risky zones and among behavioral models, and how it capitalizes in prices after the introduction of compulsory insurance for all flood-prone properties. We employ a novel combination of methods, enhancing the traditional hedonic analysis with agent-based computational economics (ACE). Our results indicate that an increase in flood insurance uptake may provide such a mechanism by lowering property values in the flood zone consistently, independent of the level of homeowners’ risk perceptions. We highlight the usefulness of our method in capturing the marginal implicit price of homeowners’ preferences that may change over time, and assess separately the effect of various factors and policies on property values.