Can the Risks of the Kyoto Mechanisms Be Reduced Through Portfolio Diversification? Evidence from the Swedish Aij Program

Through Joint Implementation and the Clean Development Mechanism, reductions of greenhouse gas emissions achieved abroad can be credited to domestic firms. However, the technical, economic and political risks involved may prevent the private sector from investing in such projects. This paper describes three types of risks which emission reduction projects are exposed to. 11 pilot projects carried out under the Activities Implemented Jointly (AIJ) program and financed by Sweden are evaluated. Actual project costs are found to exceed projected costs in all cases. Annual emission reductions also deviate from their expected values and vary strongly over time, supporting the hypothesis that such projects are risky business. The risk management tool portfolio diversification is applied to a sample of Swedish AIJ projects. The results indicate that diversification can reduce the risks of greenhouse gas mitigation projects significantly. Thus, carbon funds are a promising way of lowering the risks of the Kyoto mechanisms for private sector investors