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Price volatility and risk exposure: on the interaction of quota and product markets

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Author Info
Baldursson, Fridrik M.
von der Fehr, Nils-Henrik M.

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Abstract

We consider an industry with firms that produce a final good emitting pollution to different degree as a side effect. Pollution is regulated by a tradable quota system where some quotas may have been allocated at the outset, i.e. before the quota market is opened. We study how volatility in quota price affects firm behaviour, taking into account the impact of quota price on final-good price. The impact on the individual firm differs depending on how polluting it is - whether it is `clean' or `dirty'- and whether it has been allocated quotas at the outset. In the absence of long-term or forward contracting, the optimal initial quota allocation turns out to resemble a grandfathering regime: clean firms are allocated no quotas - dirty firms are allocated quotas for a part of their emissions.With forward contracts and in the absence of wealth effects initial quota allocation has no effect on firm behaviour.

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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 14994.

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Date of creation: Apr 2009
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Handle: RePEc:pra:mprapa:14994

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Related research
Keywords: regulation; effluent taxes; tradable quotas; uncertainty; risk aversion; environmental management;

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Find related papers by JEL classification:
Q38 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Government Policy (includes OPEC Policy)
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy
D9 - Microeconomics - - Intertemporal Choice and Growth
H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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  1. Yohe, Gary Wynn, 1977. "Comparisons of price and quantity controls: A survey," Journal of Comparative Economics, Elsevier, vol. 1(3), pages 213-233, September. [Downloadable!] (restricted)
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  4. Anastasios Xepapadeas, 1999. "Environmental Policy and Firm Behavior: Abatement Investment and Location Decisions Under Uncertainty and Irreversibility," NBER Technical Working Papers 0243, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Viaene, Jean-Marie & Zilcha, Itzhak, 1998. "The Behavior of Competitive Exporting Firms under Multiple Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 591-609, August.
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  8. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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  10. Zhao, Jinhua, 2003. "Irreversible Abatement Investment under Cost Uncertainties: Tradable Emission Permits and Emissions Charges," Staff General Research Papers 10223, Iowa State University, Department of Economics.
    Other versions:
  11. John Pezzey, 2003. "Emission Taxes and Tradeable Permits A Comparison of Views on Long-Run Efficiency," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 26(2), pages 329-342, October. [Downloadable!] (restricted)
  12. Adar, Zvi & Griffin, James M., 1976. "Uncertainty and the choice of pollution control instruments," Journal of Environmental Economics and Management, Elsevier, vol. 3(3), pages 178-188, October. [Downloadable!] (restricted)
  13. Richard Green, 2008. "Carbon Tax or Carbon Permits: The Impact on Generators Risks," The Energy Journal, International Association for Energy Economics, vol. 29(3), pages 67-90.
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  14. David M. Newbery, 2008. "Climate Change Policy and Its Effect on Market Power in the Gas Market," Journal of the European Economic Association, MIT Press, vol. 6(4), pages 727-751, 06. [Downloadable!] (restricted)
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  15. Nickell, Stephen J, 1977. "The Influence of Uncertainty on Investment," Economic Journal, Royal Economic Society, vol. 87(345), pages 47-70, March. [Downloadable!] (restricted)
  16. Batra, Raveendra N & Ullah, Aman, 1974. "Competitive Firm and the Theory of Input Demand under Price Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 537-48, May/June. [Downloadable!] (restricted)
  17. Stavins, Robert N., 1996. "Correlated Uncertainty and Policy Instrument Choice," Journal of Environmental Economics and Management, Elsevier, vol. 30(2), pages 218-232, March. [Downloadable!] (restricted)
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