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

This project in 2013 built on previous collaboration concerning real options modeling and applications to energy investments and the implementation of REDD (Reducing Emissions from Deforestation and forest Degradation).

Big trees © K. Platzer | IIASA

Big trees

This research took place as part of the NORAD-funded project "Options Market and Risk-Reduction Tools for REDD+," which aims to help design, catalyze and launch pilot options transactions for REDD+ credits, attracting private companies and investors to finance high quality results-based REDD+ programs over near and medium terms.

The project aims to design complementary instruments to reduce risks for both buyers and sellers of jurisdiction-scale REDD+ credits, and make the most effective use of limited public funds to leverage private financing and supply development.

The Methods for Economic Decision Making under Uncertainty (MEDU) group applied a real options approach modeling stochastic carbon-saving technology costs and stochastic CO2 costs. Assuming that firms are risk-averse, it was found that they value both the flexibility and risk reductions resulting from diversification across different (carbon mitigation) options.

Figure 1. R&D value and investment timing as a function of the CO2 starting price (EUR/ton).

Figure.

References

[1] Szolgayová J, Golub A, Fuss S (submitted). Innovation & risk-averse firms: options on carbon allowances as a hedging too. Energy Policy.


Collaborators

Mercator Research Institute on Global Commons and Climate Change (MCC), Berlin, Germany;
EDF, USA.


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Last edited: 22 May 2014

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