Flexibility premium of emissions permits

Investments in abatement technology are often characterised by irreversibility and significant implementation lags, whereas emissions permits can be traded at any time. As such, abatement and emissions permit trading systems are hardly perfect substitutes. We formally study the flexibility of emissions permits and propose a unified framework to rationalise the impact of both investment/divestment lags and irreversibility in relation to the price of emissions permits. Using option pricing concepts, we reformulate the technology adoption problem in terms of the technology’s characteristics (irreversibility and implementation lags) and offer a conceptual quantification of the flexibility premium of emissions permits.

Luca Taschini, Flexibility premium of emissions permits, Journal of Economic Dynamics and Control, 2020, 104013, ISSN 0165-1889, https://doi.org/10.1016/j.jedc.2020.104013.