Too Levered for Pigou: Carbon pricing, financial constraints, and leverage regulation

Robin Döttling and Magdalena Rola-Janicka

Journal of Financial Economics, 2025, vol. 172, issue C

Abstract: We analyze optimal carbon pricing under financial constraints and endogenous climate-related transition and physical costs. The socially optimal emissions tax may be above or below a Pigouvian benchmark, depending on the strength of physical climate impacts on pledgeable resources. We derive necessary conditions for emissions taxes alone to implement a constrained-efficient allocation, and show a cap-and-trade system may dominate emissions taxes because it can be designed to have a less adverse effect on financial constraints. We also assess how capital structure, carbon price hedging markets, and socially responsible investors interact with emissions pricing, and evaluate other commonly used policy tools.

Keywords: Pigouvian tax; Carbon tax; Cap and trade; Financial constraints; Climate risk; Financial regulation (search for similar items in EconPapers)
JEL-codes: D62 G28 G32 G38 H23 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:172:y:2025:i:c:s0304405x25001138

DOI: 10.1016/j.jfineco.2025.104105

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