Working Papers

Reducing Carbon Using Regulatory and Financial Market Tools with Franklin Allen and Adelina Barbalau.

This paper studies the interaction of regulatory and capital market tools for pricing and reducing carbon emissions. We present a linear model in which standard and environmentally-oriented entrepreneurs can adopt polluting and non-polluting technologies, with the latter being less profitable than the former. A carbon tax can correct the laissez-faire economy in which the polluting technology is adopted by standard entrepreneurs, but requires sufficient political support. Carbon-contingent securities provide an alternative price incentive for standard entrepreneurs to adopt the non-polluting technology, but require sufficient funds to fully substitute the regulatory tool. Absent political support for the tax, carbon-contingent securities can only improve welfare, but the same is not true when some support for a carbon tax exists. We generalize the model to allow for a continuous distribution of environmental preferences and convex emissions abatement costs. The extended model rationalizes the co-existence of regulatory and capital market tools within one economy, and allows us to understand the conditions under which combining these two tools can enhance welfare.

The Optimal Design of Green Securities, with Adelina Barbalau.

We develop a model of green project financing which incorporates investors with green preferences into an otherwise standard framework of corporate financing with asymmetric information. Firms seek to finance green projects whose outcomes embed an uncertain component that is revealed only to the firm and which can be manipulated. Firms can raise funds using non-contingent green debt contracts, such as green bonds, that specify ex-ante the projects to be financed using the proceeds, but make no commitment to green outcomes. Alternatively, they can use outcome-based contingent contracts, such as sustainability-linked bonds, that do not impose restrictions on the use of proceeds but embed contingencies which incentivize commitment to outcomes. We demonstrate that the co-existence of the two green debt contracts is an equilibrium result when reported green outcomes are manipulable and firm types differ in their ability to manipulate. In the presence of asymmetric information about firms’ type, non-contingent debt can be used as an expensive signalling device, and we find empirically that contingent green debt securities have higher yields and are issued by more emissions intensive firms.

Presentations: Western Finance Association (WFA) Annual Meetings 2022, CEPR Paris Symposium 2022, 9th HEC-McGill Finance Workshop, ESG and Climate Finance Conference: An Adam Smith Business School COP26 Event, Seventh Annual Volatility Institute at NYU Shangai Conference “Climate Risk-Modeling, Financial and Economic Impacts, and Response”, 4th joint research conference on firm financing, organization and dynamics: “New challenges facing firms in the post-Covid world”, New Zealand Finance Meeting, Imperial College London

Climate Regulation and Emissions Abatement: Theory and Evidence from Firms’ Disclosures, with Tarun Ramadorai, r&r Management Science, 2021.

We construct measures of firms’ beliefs about climate regulation, plans for future abatement, and current actions on emissions mitigation, using Carbon Disclosure Project data. These measures vary significantly around the Paris climate change agreement an- nouncement. A dynamic model of a representative firm exposed to a future carbon levy, trading-off emissions reduction against capital growth, and facing convex emissions abatement adjustment costs cannot explain these patterns. A two-firm model with cross-firm information asymmetry and reputational externalities does far better. Our findings imply that abatement is strongly affected by firms’ beliefs about climate regulation, with cross-firm interactions amplifying the effectiveness of regulation.

Presentations: Western Finance Association (WFA) 2020 Annual Meetings, HEC Paris Spring Finance Conference, UZH Young Researcher Workshop on Climate Finance, Bank of Italy, Imperial College London

Mitigating leakage risk under information asymmetry: evidence from the United Kingdom.

This paper uses a model and data from a large-scale corporate climate regulation in the United Kingdom to study the cost-effectiveness of carbon tax policies subject to carbon leakage risk and asymmetric information. The model shows that when regulated firms can relocate to unregulated jurisdictions, a standard carbon tax is sub-optimal in that it generates carbon leakage losses that can be alleviated by subsidizing firms at risk of relocation. However, in presence of a binding budget constraint on the pollution subsidies, cost-efficiency requires the regulator’s knowledge of carbon leakage propensities across firms. In line with evidence collected from the UK climate policy, the model shows that when the regulator is asymmetrically informed about firms’ emissions abatement cost, subsidies are most likely to favour emissions intensive industries. A quantitative exercise suggests that, under the same government budget allocated for the actual policy, counterfactual cost-efficient subsidies that include financial constrains and a latent factor in firms’ emissions abatement could have improved welfare of 20% in expectation.

Presentations: Bank of Italy, Imperial College London, European Association of Environmental and Resource Economics (EAERE) 2022

Risk Premium in the Era of Shale Oil, with Fabrizio Ferriani, Filippo Natoli, and Giovanni Veronese.

The boom in the production of shale oil in the United States has triggered a structural transformation of the oil market. We show, both theoretically and empirically, that this process has significant consequences for oil risk premium. We construct a model based on shale producers interacting with financial speculators in the futures market. Compared to conventional oil, shale oil technology is more flexible, but producers have higher risk aversion and face additional costs due to their reliance on external finance. Our model helps to explain the observed pattern of aggregate hedging by US oil companies in the last decade. The empirical analysis shows that the hedging pressure of shale producers has become more important than that of conventional producers in explaining the oil futures risk premium.

Presentations: Southwestern Finance Association (SWFA) 2019 Annual Meetings, Irish Academy of Finance, Bank of Italy, Imperial College London

Earlier Published Work

Representation of non-Markovian optimal stopping problems by constrained BSDEs with a single jump, with Marco Furhman and Huyên Pham, Electronic Communications in Probability, 2016.