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Banking and price containment in the California greenhouse gas emissions market: an experimental analysis of market design

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We use a set of economic experiments to test the effects of two key features of California's new program for limiting greenhouse gas emissions. The cap & trade scheme included in the program includes two novel features, limits on allowance ownership (or 'holding limits') and a tiered price containment reserve sale. These program features are linked by their potential to affect liquidity in the market for emission allowances. We examine the effects of these features on liquidity and on measures of market performance including efficiency, price discovery, and price variability. We find that tight holding limits have the effect of substantially lowering the number of banked allowances available for trade, hence lowering liquidity. This impairs the ability of traders to smooth prices over time resulting in lower efficiency, less effective price discovery, and higher variability in price. The price containment reserve, while increasing the supply of allowances available to traders, does not appear to mitigate the effects of tight holding limits on market outcomes. As a result, the imposition of holding limits in the allowance market may have the consequence of increasing the likelihood of the market manipulation that they were intended to prevent.

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Paper provided by Center for Economic and Policy Studies in its series Working Papers with number 2013-01.

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Date of creation: 01 Mar 2013
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Handle: RePEc:vac:wpaper:wp13-01

Note: A much revised draft of this working draft will appear in the Journal of Economic Behavior and Organization (2014) under the title: Elements of emission market design: an experimental analysis of California's market for greenhouse gas allowances
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Keywords: cap and trade; uniform price auction; market liquidity; price containment reserve; emission markets; carbon markets;

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  1. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 311-336, September.
  2. 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.
  3. Fell, Harrison & Burtraw, Dallas & Morgenstern, Richard D. & Palmer, Karen L., 2012. "Soft and hard price collars in a cap-and-trade system: A comparative analysis," Journal of Environmental Economics and Management, Elsevier, vol. 64(2), pages 183-198.
  4. M. L. Weitzman, 1973. "Prices vs. Quantities," Working papers 106, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Tālis J. Putniņš, 2012. "Market Manipulation: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 26(5), pages 952-967, December.
  6. Hart, Oliver D, 1977. "On the Profitability of Speculation," The Quarterly Journal of Economics, MIT Press, vol. 91(4), pages 579-97, November.
  7. Juan-Pablo Montero, 2009. "Market Power in Pollution Permit Markets," The Energy Journal, International Association for Energy Economics, vol. 0(Special I).
  8. Hasegawa, Makoto & Salant, Stephen, 2012. "Cap-and-Trade Programs under Delayed Compliance," Discussion Papers dp-12-32, Resources For the Future.
  9. Juan-Pablo Montero, 2009. "Market Power in Pollution Permit Markets," Working Papers 0906, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  10. Hahn, Robert W., 1982. "Market Power and Transferable Property Rights," Working Papers 402, California Institute of Technology, Division of the Humanities and Social Sciences.
  11. Roberts, Marc J. & Spence, Michael, 1976. "Effluent charges and licenses under uncertainty," Journal of Public Economics, Elsevier, vol. 5(3-4), pages 193-208.
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