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Optimal Trading Ratios for Pollution Permit Markets

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  • Stephen Holland
  • Andrew J. Yates

Abstract

We analyze a novel method for improving the efficiency of pollution permit markets by optimizing the way in which emissions are exchanged through trade. Under full-information, it is optimal for emissions to exchange according to the ratio of marginal damages. However, under a canonical model with asymmetric information between the regulator and the sources of pollution, we show that these marginal damage trading ratios are generally not optimal, and we show how to modify them to improve efficiency. We calculate the optimal trading ratios for a global carbon market and for a regional nitrogen market. In these examples, the gains from using optimal trading ratios rather than marginal damage trading ratios range from substantial to trivial, which suggests the need for careful consideration of the structure of asymmetric information when designing permit markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19780.

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Date of creation: Jan 2014
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Handle: RePEc:nbr:nberwo:19780

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  1. Harrison Fell & Richard Morgenstern, 2010. "Alternative Approaches to Cost Containment in a Cap-and-Trade System," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 47(2), pages 275-297, October.
  2. R. Scott Farrow & Martin T. Schultz & Pinar Celikkol & George L. Van Houtven, 2005. "Pollution Trading in Water Quality Limited Areas: Use of Benefits Assessment and Cost-Effective Trading Ratios," Land Economics, University of Wisconsin Press, vol. 81(2).
  3. Feng, Hongli & Zhao, Jinhua, 2002. "Alternative Intertemporal Permit Trading Regimes with Stochastic Abatement Costs," Staff General Research Papers 10057, Iowa State University, Department of Economics.
  4. Stocking, Andrew, 2012. "Unintended consequences of price controls: An application to allowance markets," Journal of Environmental Economics and Management, Elsevier, vol. 63(1), pages 120-136.
  5. Curtis Carlson & Dallas Burtraw & Maureen Cropper & Karen L. Palmer, 2000. "Sulfur Dioxide Control by Electric Utilities: What Are the Gains from Trade?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(6), pages 1292-1326, December.
  6. Roberton Williams, 2002. "Prices vs. Quantities vs. Tradable Quantities," NBER Working Papers 9283, National Bureau of Economic Research, Inc.
  7. Carlos Chávez & John Stranlund, 2009. "A Note on Emissions Taxes and Incomplete Information," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 44(1), pages 137-144, September.
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