Management of risks in clean development mechanism projects

Abstract

The clean development mechanism (CDM) is attracting increased attention because it is a promising method for economic reduction of greenhouse gas emissions and is expected to reduce the economic gaps between developed and developing nations. We investigated how to quantify and manage risks in CDM from the viewpoint of the investor. Real option theory was applied to quantify project risks in CDM so that we could quantitatively compute the option values. A mathematical model of CDM was represented with a compound rainbow option, which included continuous procedures from registration to investment. The evaluated results identified the condition of profitability in which investment as CDM is feasible. Our evaluation quantified how CDM projects become difficult to execute due to registration risk and post-2012 risk. In particular, registration risk was shown to make stronger adverse impact on CDM than post-2012 risk. We also investigated the effect of procuring certified emission reduction (CER) by government. Based on actual financial data on CDM, we investigated how the risks and the procurement influence the number of executable CDM projects. Quantitative estimation was made on the effect of reducing risk by our real option analysis and the number of feasible CDM projects was evaluated using the actual data.