Title: Green Hedge Business: Minimization of Carbon Emission Costs and Design of Carbon-Linked Instruments

Speaker: Prof. Andrea Macrina (University College London; University of Cape Town)

Abstract: After introducing the carbon equivalence principle, we briefly review the stock-flow-consistent macroeconomics framework in a climate change setting. We consider the minimization of carbon costs in continuous time in the situation where the carbon emission price is assumed stochastic. The stochastic optimal emissions reduction policy is obtained when the so-called marginal financial net-zero equation is satisfied. In practice, however, no firm would be in a position to adjust their optimal emissions reduction strategy continuously. This would require continuous monitoring and adaptation. Therefore, we treat the simplest case where a firm calculates their optimal reduction strategy based on a time-zero-expected future carbon price. As the stochastic carbon price evolves and the firm’s emissions reduction policy no longer is optimal, the firm absorbs a carbon price deviation cost that cannot be transferred. This price deviation cost suggests the design and introduction of carbon-linked hedge instruments reminiscent of inflation-linked derivatives. Such carbon-linked financial instruments are expected to produce a feedback effect in the stock-flow-consistent economy and an impact on governmental carbon policy choices.