A contingent claims analysis of optimal investment subsidy

Norvald Instefjord, Vivekanand Nawosah and Pei Yang

Journal of Economic Dynamics and Control, 2016, vol. 73, issue C, 354-372

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.

Keywords: First-mover advantages; Free riding; Investment subsidy; Preemption risk; Subsidy tax (search for similar items in EconPapers)
JEL-codes: D92 E62 G31 H21 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:73:y:2016:i:c:p:354-372

DOI: 10.1016/j.jedc.2016.10.004

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