Optimal subsidy policy to promote building energy efficiency under uncertainty : the case for architectural design subsidies

Abstract

The goal of this thesis is to examine the relative cost-effectiveness of subsidies in incentivizing energy efficiency investment using a real option framework. I generalize a model of a sequential investment project involving two stages, design and construction stage, and investment lags and incorporate explicit consideration of dynamic subsidies. I apply this model to green construction projects and study how design subsidies and rent subsidies incentivizes investment in green buildings. My research questions address the impact of subsidies on the trigger prices for the two stages as well as that on the instantaneous project value. Although both design and rent subsidies can reduce trigger prices and enhance project value, design subsidies cost less both in reducing the first-stage trigger to a certain threshold and in inducing firms to switch from inefficient projects to efficient ones. Lastly, I evaluate the comparative statics of investment, showing how the patterns of lags and demand uncertainty affect the effectiveness of both subsidies. A noteworthy result is that quality switching from an inefficient project to an green alternative is more likely to occur when the uncertainty is smaller or the length of the construction stage is shorter.