Preferences in Flood-prone Housing Markets

The price of risk is an important indicator that can facilitate decisions in any risk mitigation policy, which demands for methods to value the social costs of risk as accurately as possible. In particular, in flood risk management the central number that influences the balance between costs and benefits is the price of flood risk.

There are two main approaches to assess this value for households (1) the revealed preference method through hedonic pricing of risk and (2) the stated preference method through surveys and choice experiments. Besides their own advantages and disadvantages, there are consistent differences between the two methods over various applications, also outside flood risk management. 

This paper serves as the first step in unravelling the interplay of various biases on the gap between the two estimation techniques with a special focus on the value of simulation techniques in this analysis. Thus, we highlight only on two aspects – violations from the expected utility framework and spatial correlation of property attributes that may confuse risk assessments. 

The paper’s aim is to quantitatively explore (1) the market-level consequences of various behavioural models’ assumptions regarding risky choices at the individual level, and (2) the effect of the market-level bias that individual preferences for neighbourhood quality imply. By pursuing this dual goal, we contribute to understanding the gap between individual choices, on which stated preference methods rely, and observed market outcomes based on revealed preferences methods.