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

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  • Margaret Insley

Abstract

Optimal decisions of a firm facing the option of retrofitting its plant to reduce pollution and thereby eliminate the need to purchase emissions allowances are analysed. The decision is treated as a real option with the price of pollution permits following 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 makes optimal decisions about the retrofit, including whether to mothball temporarily. The model is used to analyse a firm's decision to instal a scrubber as a result of the 1990 U.S. Clean Air Act.

Suggested Citation

  • Margaret Insley, 2003. "On the option to invest in pollution control under a regime of tradable emissions allowances," Canadian Journal of Economics, Canadian Economics Association, vol. 36(4), pages 860-883, November.
  • Handle: RePEc:cje:issued:v:36:y:2003:i:4:p:860-883
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    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; Fixed Investment and Inventory Studies

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