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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

    (Department of Economics, University of Waterloo)

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.

Suggested Citation

  • Margaret Insley, 2002. "On the option to invest in pollution control under a regime of tradable emissions allowances," Working Papers 02008, University of Waterloo, Department of Economics, revised Jan 2002.
  • Handle: RePEc:wat:wpaper:02008
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    References listed on IDEAS

    as
    1. Benson, B.L. & Mast, B.D. & Rasmussen, D.W., 1997. "Deterring Drunk Driving Fatalities: An Economics of Crime Perspective," Working Papers 1997_03_01, Department of Economics, Florida State University.
    2. Ruhm, Christopher J., 1996. "Alcohol policies and highway vehicle fatalities," Journal of Health Economics, Elsevier, vol. 15(4), pages 435-454, August.
    3. Benson, Bruce L. & Rasmussen, David W. & Mast, Brent D., 1999. "Deterring drunk driving fatalities: an economics of crime perspective1," International Review of Law and Economics, Elsevier, vol. 19(2), pages 205-225, June.
    4. Dee, Thomas S., 1999. "State alcohol policies, teen drinking and traffic fatalities," Journal of Public Economics, Elsevier, vol. 72(2), pages 289-315, May.
    5. Anindya Sen, 2001. "Do stricter penalties deter drinking and driving? An empirical investigation of Canadian impaired driving laws," Canadian Journal of Economics, Canadian Economics Association, vol. 34(1), pages 149-164, February.
    6. Mullahy, John & Sindelar, Jody L, 1993. "Alcoholism, Work, and Income," Journal of Labor Economics, University of Chicago Press, vol. 11(3), pages 494-520, July.
    7. Young, Douglas J. & Likens, Thomas W., 2000. "Alcohol Regulation and Auto Fatalities," International Review of Law and Economics, Elsevier, vol. 20(1), pages 107-126, March.
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    More about this item

    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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