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On the option to invest in pollution control under a regime of tradable emissions allowances

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Author Info
Margaret Insley (Department of Economics, University of Waterloo)

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Abstract

This paper analyses the optimal decision of a firm faced with the option of retrofitting its plant to reduce pollution and thereby eliminate the need to purchase emissions allowances. The decision is treated as a real option with the price of pollution permits assumed to follow a known stochastic process. The model is formulated as a set of one-dimensional partial differential equations. At discrete points in time, the firm owner is assumed to make optimal decisions about the retrofitting. In addition, if mothballing is allowed, the owner can halt the installation, with the option of resuming at later date. Optimality conditions are imposed at each decision date, which link the set of one-dimensional partial differential equations. The model is used to calculate critical permit prices at which the firm should choose to retrofit.

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Publisher Info
Paper provided by University of Waterloo, Department of Economics in its series Working Papers with number 02008.

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Date of creation: Jan 2002
Date of revision: Jan 2002
Handle: RePEc:wat:wpaper:02008

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Postal: Waterloo, Ontario, N2L 3G1
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Find related papers by JEL classification:
Q25 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Water
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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  1. Katrin Millock & Céline Nauges & Åsa Löfgren, 2007. "Using Ex Post Data to Estimate the Hurdle Rate of Abatement Investments – An Application to the Swedish Pulp and Paper Industry and Energy Sector," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00272041_v1, HAL. [Downloadable!]
  2. Ulrich Blum & Werner Gleißner & Frank Leibbrand, 2005. "Stochastische Unternehmensmodelle als Kern innovativer Ratingsysteme," IWH Discussion Papers 6-05, Halle Institute for Economic Research. [Downloadable!]
  3. Hammar, Henrik & Löfgren, Åsa, 2007. "Explaining adoption of end of pipe solutions and clean technologies," Working Paper 102, National Institute of Economic Research. [Downloadable!]
  4. Frank Krysiak, 2008. "Ex-post efficient permit markets: a detailed analysis," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 39(4), pages 397-410, April. [Downloadable!] (restricted)
  5. Atsuyuki Ohyama & Motoh Tsujimura, 2006. "Political Measures for Strategic Environmental Policy with External Effects," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 35(2), pages 109-135, October. [Downloadable!] (restricted)
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