Valuing investments in the Global Carbon Market Mechanism as compound real options: Lessons from the Clean Development Mechanism

Cassimon, Danny, Engelen, Peter-Jan, Peters, Linda and Prowse, Martin ORCID: https://orcid.org/0000-0002-1271-468X (2023) Valuing investments in the Global Carbon Market Mechanism as compound real options: Lessons from the Clean Development Mechanism. Sustainable Development, 31 (5). pp. 3443-3458. ISSN 0968-0802

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Abstract

The Global Carbon Market Mechanism (GCMM) aims to incentivize national or sub-national actors to invest in climate mitigation projects at the same time as limiting the global costs of tackling global warming. Using the worked example of the Clean Development Mechanism (CDM), this article shows that the exact valuation of a mitigation project requires the application of compound real options techniques, as it is able to account for the multi-staged nature of a project cycle, as well as the two basic sources of uncertainty (the probability of not moving successfully to the next stage of the cycle, technical risk, and the uncertainty related to future emission reduction credit prices, market risk). Using parameters from the global database of registered CDM projects, this article illustrates that longer than projected lead times, higher than projected transaction costs, and higher than projected rates of failure lowered the value of investing in CDM projects considerably, alongside offset prices and their variability. Regulators of and participants within the patchwork of existing emission trading schemes and market mechanisms, including the GCMM (Article 6.4 of the Paris Agreement), could benefit through wider appreciation of the benefits of this valuation method.

Item Type:	Article
Uncontrolled Keywords:	sdg 13 - climate action ,/dk/atira/pure/sustainabledevelopmentgoals/climate_action
Faculty \ School:	Faculty of Social Sciences > School of Global Development (formerly School of International Development)
Depositing User:	LivePure Connector
Date Deposited:	22 May 2023 14:30
Last Modified:	07 Oct 2023 01:19
URI:	https://ueaeprints.uea.ac.uk/id/eprint/92126
DOI:	10.1002/sd.2595

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