Optimal abatement investment and environmental policies under pollution uncertainty

In this paper we present a continuous time model with reversible abate- ment capital in order to analyze the e§ects of environmental policies on the value of the Örm and investment decisions. We show that the e§ects depend on what sort of future policy are implemented. We focus on investment ef- fects of changes in corrective taxes to control the use of polluting inputs, and subsidies to promote abatement investment. We show that (1) while taxes have a depressive e§ect on capital accumulation, subsidies boost investment; (2) the impact of these policies on the value of the Örm is ambiguous. This latter result has important empirical implications insofar as investment are based on the average value of the Örm rather than the (unobservable) mar- ginal value