Dynamic Carbon Emission Management

Abstract

The control of carbon emissions by policymakers poses the corporate challenge of developing an optimal carbon management policy. We provide a unified model that characterizes how firms should optimally manage emissions through production, green investment, and the trading of carbon credits, as well as the implications for asset prices. We show that carbon regulation induces firms to tilt towards more immediate yet transient types of green investment---such as abatement as opposed to innovation---as it becomes more costly to comply. Perhaps surprisingly, firms with a large stock of carbon credits are less committed to curbing emissions. Lastly, even if more polluting firms command a higher risk premium, carbon regulation need not reduce firm value.

Keywords: Carbon Emissions, Carbon Abatement, Green Innovation, Carbon Credits, Carbon Trading, Carbon Tax, Asset Prices

JEL Classification: G30,G31,G12,D62,O33