Regulated correlations — climate policy and investment risks


Neupert-Zhuang, Menglu ; Schenker, Oliver


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URN: urn:nbn:de:bsz:180-madoc-687680
Document Type: Working paper
Year of publication: 2024
The title of a journal, publication series: ZEW Discussion Papers
Volume: 24-064
Place of publication: Mannheim
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: D81 , E22 , G11 , P48,
Keywords (English): climate policy , investment under uncertainty , modern portfolio theory , risk aversion
Abstract: Investments in energy technologies are substantially governed by climate policy. We demonstrate analytically that price-based instruments, such as carbon-taxes, and quantity-based regulations, like emission trading systems, have distinct effects on the (co-)variance of power plant profits. If investors are risk-averse, these differences lead to divergent investment portfolios, breaking the equivalence of price- and quantity-based policy instruments under risk-neutrality. Using the European power sector as a case study, we calibrate an electricity market model with stochastic demand and find that, compared to a carbon tax, emissions trading pushes up the share of fossil fuel assets in a representative investor’s portfolio since counteracting effects of permit and electricity prices reduce the covariance with other technologies, thereby enhancing the diversification value of these assets. Uncertainty about the stringency of carbon taxes leads to lower shares of fossil fuel assets with increasing risk aversion.




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