Investing in finite-life carbon emissions reduction program under risk and idiosyncratic uncertainty

Abstract

This paper aims at emphasizing the ability of new frameworks of real option model to highlight key characteristics of industrial Carbon Emissions Reduction Program investment decision. We develop both theoretical arguments and numerical simulations with structural parameters calibrated on real-life data. We find that both radical uncertainty and risk lead to speed-up green investments, compared to the predictions of real option models that are normally used in green investment literature. The conventional “wait and see” attitude, questioned in recent developments of the real option theory, is not validated. In conclusion, our results should foster companies to implement green investments and help governments to define appropriate incentives to encourage green investments. Of particular note, the paper highlights that finance theory is not necessarily an obstacle to green investment decisions.