Do Policy Incentives to Buildings Energy Retrofit Encourage Homeowners’ Free-Rider Behavior?

To encourage homeowners in undertaking buildings energy-efficient renovations, Governments have introduced a wide range of incentive measures. Nonetheless, the cost-effectiveness of this incentive policy is controversial. The general perception is that incentives are costly and, if they are not optimally designed, they can attract free riders and generate undesirable outcomes to efficient resource allocation and to Society. In this paper, we investigate whether investments in buildings energy retrofit (BER) are be profitable in the phasing out of incentives and if current incentive policy encourage homeowners’ free-rider behavior. In detail, we analyze the investment decision of a homeowner, who has to undertake retrofit interventions of an existing building, regardless incentives are cancelled out. In detail, we develop and implement a Real Option Model to determine the investment value and its optimal timing, by modeling the opportunity to invest as a call option. Our results show that negative NPV investments may turn to be profitable if the option to defer is optimally exercised. The value of flexibility to invest adds to the investment value and make incentive schemes not necessary in encouraging investments in BER. By contrast, current fiscal incentive policy in Italy may attract free riders and generate an over-investment effect, which in turn increase costs for Government and Society