Sellers' hedging incentives at EPA's emission trading auction

Cason (1993)argued thattheauction theEPAused in order to start the market for sulfur allowances, is not efficient. The set-up of the auction gives both buyers and sellers an incentive to understate their valuation of an allowance. In this paper, we show that the sellers’ incentives are even more perverse than Cason suggested. In particular, we show that sellers have an incentive to set their ask price equal to zero, while simultaneously hedging their bets by submitting a positive bid. It is not possible to derive the Nash equilibrium for this set-up. If such an equilibrium exists, sellers either set only a positive ask price, or an ask price equal to zero, and a positive bid as well.