Reinforcement Learning: Experience Effect in Climate Risk Assessment
Despite the growing severity and frequency of climate events, there remains a significant gap in how climate risks are perceived by the public and professionals. These risks are often seen as distant problems, unlikely to affect current operations or investments. This misperception is stark in the property market, where home buyers and sellers, responsible for evaluating property values under potential risk scenarios, frequently overlook or inadequately integrate these risks into their assessments. The challenge extends beyond homeowners to professionals advising in financial and property markets, who also struggle to incorporate these risks into their decision-making processes. As climate change intensifies, it is necessary to understand and respond to climate risks. An important element in this understanding is the "experience effect." This isn't just about remembering to bring an umbrella after getting soaked once; it extends to complex decision-making in high-stakes environments.
Research has shown that personal and professional experiences significantly influence how individuals perceive and react to risks. One notable example is the work of Ulrike Malmendier (Berkeley Haas), who has extensively studied how direct experiences impact professional decision-making and risk assessment. Malmendier’s studies suggest that individuals who have experienced significant economic downturns, like the Great Recession, often develop a more cautious approach to financial risks. This heightened risk aversion can be observed in various professional sectors, including fund management and financial advisory. These professionals tend to be more conservative in their investment strategies, preferring safer assets over potentially higher-yielding but riskier investments. This behavior is driven by the lasting impact of their stressful economic experiences, which alter their perception of financial stability and risk.
Drawing parallels to climate risk assessment in real estate markets, similar dynamics can be observed. Individuals who have experienced firsthand the devastation of climate-related events, such as floods or hurricanes, are likely to adjust their valuations of properties at risk to better reflect these risks. Empirical evidence of the effect of experience in updating risk perceptions has been found in the flood insurance market and the housing transaction market. Just as with financial crises, the frequency and intensity of these experiences play a crucial role in how persistently these perceptions are held. However, the integration of experience-based learning in climate risks is always short-lived, and is pretty costly to stakeholders in the market, including investors, insurers, lenders, and government bodies, and presents several challenges:
- Frequency of exposure: Unlike economic cycles like recessions, which have a broad and often prolonged impact, climate events can be more localized and temporary. This can lead to inconsistent updates in risk perceptions among individuals who might not regularly face these issues.
- Educational and regulatory frameworks: Current training and regulatory guidelines may not adequately emphasize the importance of integrating such experiences into professional evaluations or transaction disclosures. There is a need for more targeted educational programs that address specific climate risks and provide real-world examples of how to incorporate these risks into valuation practices.
- Transience of experience effect: The impact of experiential learning, while profound, can often be short-lived. As individuals face new experiences or as time distances them from past events, the vividness and urgency of the lessons learned may begin to fade. This fading effect poses a challenge in risk assessment where continuous awareness and adaptation are required.
To mitigate these challenges, individuals must have easy access to understandable flood risk information. Regular updates to education and assessment protocols can help reinforce and refresh the lessons learned, ensuring that the experience effect remains a dynamic and potent tool in decision-making processes. Training programs for professionals like brokers and appraisers, including comprehensive modules on risk management that highlight the importance of learning from different sources, are also necessary. Objective risk information such as flood maps, market disturbance analysis after climate event shocks, and past experiences both personal and observed can all act as great learning materials. Additionally, policy adjustments that mandate the inclusion of risk data in appraisal and investment assessments can help standardize how experiences influence professional judgments.
Imagine a real estate market that learns like a forgetful student — this is the world of the "experience effect" in property valuation. Over time, as the memories of disasters fade, so too does the urgency to factor these risks into property prices. This phenomenon creates a cycle of valuation highs and lows, influenced more by recent headlines than by long-term trends — unless, of course, the market keeps getting reminded by new "lessons".
