The present paper analyzes the investment effects of emission trading scheme (ETS) when emission permits are bankable and there is technological uncertainty with regard to the abatement cost. A real option model is employed to accommodate irreversibility of investment and cost uncertainty. In the absence of abatement cost uncertainty, a bankable ETS reduces a firm's incentive for environmental investment, because the firm can utilize the banked permits for future compliance which act as substitutes for abatement investment. However, when cost uncertainty is prevalent, investment may reduce the opportunity cost of irreversible investment under the banking system, thereby increasing a firm's investment incentive. The condition is derived under which a bankable ETS provides higher investment incentives than a non-bankable ETS does.
Bibliographical noteFunding Information:
I would like to thank Lars Olson in the University of Maryland for his comments and a series of discussions. I appreciate valuable comments and suggestions provided by anonymous referees. All remaining errors are mine. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government ( NRF-2011-327-B00126 ).
Copyright 2012 Elsevier B.V., All rights reserved.
- Emission permit
- Real option
ASJC Scopus subject areas
- Economics and Econometrics