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Innovation and risk-averse firms: Options on carbon allowances as a hedging tool


  • Szolgayová, Jana
  • Golub, Alexander
  • Fuss, Sabine


In a regulated world where government seeks to decarbonize the energy sector, firms face both indirect and direct costs of emitting CO2. This study seeks to take the perspective of the firm, which needs to maximize profits implying minimization of (carbon) cost as well. In this study, the firm can compose the cost-optimal portfolio of (a) investing into carbon-saving technology, which is currently expensive, (b) investing into carbon-saving technology R&D and adopt this technology at a later point, (c) buying allowances per ton of emitted CO2 in a carbon market (alternatively this could be formulated as a tax), and (d) buying offsets traded in the same market, which are based on reduced emissions from deforestation and degradation (REDD+). Uncertainties in the cost of carbon coming from a lack of commitment in policy-making leading to fluctuations in markets and uncertainty in the payoff of R&D activities could provide disincentives to incur large up-front sunk cost and raise the economic value of being flexible. We apply a real options approach with stochastic carbon-saving technology costs and stochastic CO2 costs. Assuming that firms are risk-averse, they will not only value flexibility, but also risk reductions from diversification over the different (carbon mitigation) options.

Suggested Citation

  • Szolgayová, Jana & Golub, Alexander & Fuss, Sabine, 2014. "Innovation and risk-averse firms: Options on carbon allowances as a hedging tool," Energy Policy, Elsevier, vol. 70(C), pages 227-235.
  • Handle: RePEc:eee:enepol:v:70:y:2014:i:c:p:227-235 DOI: 10.1016/j.enpol.2014.03.012

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    References listed on IDEAS

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    Cited by:

    1. Compernolle, T. & Welkenhuysen, K. & Huisman, K. & Piessens, K. & Kort, P., 2017. "Off-shore enhanced oil recovery in the North Sea: The impact of price uncertainty on the investment decisions," Energy Policy, Elsevier, vol. 101(C), pages 123-137.
    2. Krasovskii, Andrey & Khabarov, Nikolay & Obersteiner, Michael, 2016. "Fair pricing of REDD-based emission offsets under risk preferences and benefit-sharing," Energy Policy, Elsevier, vol. 96(C), pages 193-205.
    3. repec:eee:ecolec:v:138:y:2017:i:c:p:90-98 is not listed on IDEAS


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