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Cap-and-trade properties under different hybrid scheme designs

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  • Georg Grüll
  • Luca Taschini
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    Abstract

    This paper examines the key design mechanisms of existing and proposed cap-and-trade markets. First, it is shown that the hybrid systems under investigation (price floor using a minimum price guarantee, price collar, allowance reserve, options offered by the regulator, and offset relaxation) can be decomposed into a combination of an ordinary cap-and-trade scheme with European- or American-style call and put options. Then, we quantify and discuss the advantages and disadvantages of the proposed hybrid schemes by investigating whether pre-set objectives (enforcement of permit price bounds and reduction of the compliance costs for relevant companies) can be accomplished while maintaining the original environmental targets. Plain vanilla options are proposed as an alternative that reconciles the otherwise conflicting policy objectives.

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    File URL: http://eprints.lse.ac.uk/37597/
    File Function: Open access version.
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 37597.

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    Length: 30 pages
    Date of creation: Sep 2010
    Date of revision:
    Handle: RePEc:ehl:lserod:37597

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    Related research

    Keywords: allowance reserve; price ceiling; price collar; price floor; offset; safety valve;

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    References

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    1. Unold, Wolfram & Requate, Till, 2001. "Pollution control by options trading," Economics Letters, Elsevier, vol. 73(3), pages 353-358, December.
    2. Keeler, Andrew G., 1991. "Noncompliant firms in transferable discharge permit markets: Some extensions," Journal of Environmental Economics and Management, Elsevier, vol. 21(2), pages 180-189, September.
    3. Seifert, Jan & Uhrig-Homburg, Marliese & Wagner, Michael, 2008. "Dynamic behavior of CO2 spot prices," Journal of Environmental Economics and Management, Elsevier, vol. 56(2), pages 180-194, September.
    4. Rubin, Jonathan D., 1996. "A Model of Intertemporal Emission Trading, Banking, and Borrowing," Journal of Environmental Economics and Management, Elsevier, vol. 31(3), pages 269-286, November.
    5. Roberts, Marc J. & Spence, Michael, 1976. "Effluent charges and licenses under uncertainty," Journal of Public Economics, Elsevier, vol. 5(3-4), pages 193-208.
    6. Brian C. Murray & Richard G. Newell & William A. Pizer, 2008. "Balancing Cost and Emissions Certainty: An Allowance Reserve for Cap-and-Trade," NBER Working Papers 14258, National Bureau of Economic Research, Inc.
    7. Baumol,William J. & Oates,Wallace E., 1988. "The Theory of Environmental Policy," Cambridge Books, Cambridge University Press, number 9780521311120, October.
    8. Jacoby, Henry D. & Ellerman, A. Denny, 2004. "The safety valve and climate policy," Energy Policy, Elsevier, vol. 32(4), pages 481-491, March.
    9. Marc Chesney & Luca Taschini, 2008. "The Endogenous Price Dynamics of the Emission Allowances: An Application to CO2 Option Pricing," Swiss Finance Institute Research Paper Series 08-01, Swiss Finance Institute, revised Jan 2008.
    10. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
    11. Baumol,William J. & Oates,Wallace E., 1988. "The Theory of Environmental Policy," Cambridge Books, Cambridge University Press, number 9780521322249, October.
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