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This thesis explores a problem of how to evaluate environmental projects under the Carbon Cap-and-Trade Scheme (CCTS) from the perspective of an individual firm. The focus is the integration of a real option approach for project investment timing and financial carbon option approach for carbon credit management. The real option is for a mid or long term decision on when to invest on the environmental project, and the financial option is for a supplementary decision to hedge short-term residue risks. Two uncertainties (the carbon price and carbon credit demand) are considered, and their changes are represented by a lattice of multiple orders. Dynamic programming and linear stochastic programming are used to solve this integrated option problem under the carbon uncertainty. Numerical sensitivity analyses are also conducted by changing the parameters for the carbon price and carbon credit demand. The integrated approach can help a firm to make environmental investment decision and hedge carbon credit risks effectively under the CCTS. This research cn also helps examine the effects of different regulatory tools realted to implementing environmental projects and financial options by manufacturing firms under the CCTS so that policy-makers could design more effective environmental regulations reducing GHG emissions and manufacturers’ financial risks.
Adviser: Jeonghan Ko