Environmental Policy Implications of Extreme Variations in Pollutant Stock Levels and Socioeconomic Costs

39 Pages Posted: 18 May 2007

See all articles by Vasiliki Makropoulou

Vasiliki Makropoulou

Athens University of Economics and Business - Department of Management Science

George Dotsis

National Kapodistrian University of Athens - Faculty of Economics; Essex Finance Centre, Essex Business School, University of Essex

Raphael N. Markellos

University of East Anglia (UEA) - Norwich Business School

Date Written: February 2008

Abstract

Motivated by recent evidence on the possibility of jumps in carbon dioxide emission levels and abrupt increases in pollutant-related socio-economic costs, this paper uses a real options approach to examine their impact with respect to the optimal timing of environmental policies and the optimal emissions abatement level. To this end, we extend the methodology of Pindyck (2000) using jump diffusion processes. We show that if pollutant stock levels are subject to extreme variations and the emissions abatement level is chosen exogenously by the policymaker, then environmental policy measures should be taken earlier. A similar, yet more prominent, effect is observed under the assumption that pollutant-related socio-economic costs and benefits are expected to exhibit abrupt changes. However, different results are obtained when we examine simultaneously the two interrelated decisions, namely, the optimal timing of emissions abatement and the optimal abatement level. In this case, an increase in the size and/or probability of a jump, delays policy adoption but leads to higher optimal abatement.

Keywords: Q28, L51, H23

JEL Classification: Real Options, Environmental Policy, Jump Diffusion

Suggested Citation

Makropoulou, Vasiliki and Dotsis, George and Markellos, Raphael N., Environmental Policy Implications of Extreme Variations in Pollutant Stock Levels and Socioeconomic Costs (February 2008). Available at SSRN: https://ssrn.com/abstract=987503 or http://dx.doi.org/10.2139/ssrn.987503

Vasiliki Makropoulou (Contact Author)

Athens University of Economics and Business - Department of Management Science ( email )

Evelpidon 47A & Lefkados 33
Athens GR-11362
Greece

George Dotsis

National Kapodistrian University of Athens - Faculty of Economics ( email )

Greece

HOME PAGE: http://sites.google.com/site/gdotsis/

Essex Finance Centre, Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Raphael N. Markellos

University of East Anglia (UEA) - Norwich Business School ( email )

Norwich
NR4 7TJ
United Kingdom

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