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Regulated correlations - Climate policy and investment risks

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  • Neupert-Zhuang, Menglu
  • Schenker, Oliver

Abstract

Investments in energy technologies are substantially governed by climate policy. We demonstrate analytically that price-based instruments, such as carbon-taxes, and quantity-based regulations, like emission trading systems, have distinct effects on the (co-)variance of power plant profits. If investors are risk-averse, these differ- ences lead to divergent investment portfolios, breaking the equivalence of price- and quantity-based policy instruments under risk-neutrality. Using the European power sector as a case study, we calibrate an electricity market model with stochastic de- mand and find that, compared to a carbon tax, emissions trading pushes up the share of fossil fuel assets in a representative investor's portfolio since counteracting effects of permit and electricity prices reduce the covariance with other technologies, thereby enhancing the diversification value of these assets. Uncertainty about the stringency of carbon taxes leads to lower shares of fossil fuel assets with increasing risk aversion.

Suggested Citation

  • Neupert-Zhuang, Menglu & Schenker, Oliver, 2024. "Regulated correlations - Climate policy and investment risks," ZEW Discussion Papers 24-064, ZEW - Leibniz Centre for European Economic Research.
    • Handle: RePEc:zbw:zewdip:312183
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    References listed on IDEAS

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    More about this item

    Keywords

    Climate policy; Investment under uncertainty; Modern Portfolio Theory; Risk aversion;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • P48 - Political Economy and Comparative Economic Systems - - Other Economic Systems - - - Legal Institutions; Property Rights; Natural Resources; Energy; Environment; Regional Studies

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