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A contingent claims analysis of optimal investment subsidy

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  • Instefjord, Norvald
  • Nawosah, Vivekanand
  • Yang, Pei

Abstract

This paper uses contingent claims analysis to answer two questions: (i) why are some subsidy markets apparently slow in attracting an optimal subsidy when others are not, and (ii) what can be done about it? The lack of activity in the green investment subsidy markets has been a concern as it appears optimal that countries should offer such support from a welfare point of view but progress has nonetheless been stalling, which motivates this paper. We show that free riding (which is likely to affect the green subsidy market) cools down the subsidy market with harmful welfare effects, and preemption (which is likely to affect the more active FDI subsidy market) overheats the subsidy market with similarly harmful effects. The theory dictates a taxation scheme that offsets these effects to restore the welfare to its maximum point.

Suggested Citation

  • Instefjord, Norvald & Nawosah, Vivekanand & Yang, Pei, 2016. "A contingent claims analysis of optimal investment subsidy," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 354-372.
    • Handle: RePEc:eee:dyncon:v:73:y:2016:i:c:p:354-372
    DOI: 10.1016/j.jedc.2016.10.004
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    References listed on IDEAS

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    Cited by:

    1. Guoping Ding & Jingqian Hua & Juntao Duan & Sixia Deng & Wenyu Zhang & Yifan Gong & Huaping Sun, 2022. "Research on the Strategy of Industrial Structure Optimization Driven by Green Credit Distribution," Sustainability, MDPI, vol. 14(15), pages 1-17, July.
    2. Kai Chang & Ning Lu & Ze Sheng Li & Yi Ran Wang, 2021. "The combined impacts of fiscal and credit policies on green firm's investment opportunity: Evidences from Chinese firm‐level analysis," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(7), pages 1822-1835, October.
    3. Chang, Kai & Wan, Qiong & Lou, Qichun & Chen, Yili & Wang, Weihong, 2020. "Green fiscal policy and firms’ investment efficiency: New insights into firm-level panel data from the renewable energy industry in China," Renewable Energy, Elsevier, vol. 151(C), pages 589-597.

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    More about this item

    Keywords

    First-mover advantages; Free riding; Investment subsidy; Preemption risk; Subsidy tax;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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