Environmental Policy and Incentives to Adopt Abatement Technologies Under Endogenous Uncertainty
Government of the Italian Republic (Italy), Ministry of Economy and Finance, Department of the Treasury Working Paper No. 5
32 Pages Posted: 10 May 2013 Last revised: 17 Jul 2014
Date Written: April 19, 2013
Abstract
We compare a carbon tax and a cap and trade mechanism in their propensity to induce carbon-reducing technological adoption, when investments are undertaken under uncertainty. In our setting, risk-neutral firms affect the variance and the correlation of the shocks they are exposed to through their technological choice, making uncertainty endogenous. We find that uncertainty associated with a given technology always impacts expected profits under a carbon tax, while under a cap and trade this is the case only as long as the shocks are not correlated across the firms; if, instead, shocks are perfectly correlated, uncertainty has no impact on profits. As a result, we show that, while under a carbon tax, initially symmetric firms tend to have symmetric strategies in equilibrium (either of adoption, or non adoption), a cap and trade system might also induce asymmetric adoption. Finally, we discuss several policy applications of our work, including an analysis of the effects of combining feed-in tariffs with carbon tax or cap and trade.
Keywords: carbon tax, cap and trade, technology adoption, endogenous uncertainty
JEL Classification: L5, Q58, O33
Suggested Citation: Suggested Citation