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Optimal policy tradable and bankable pollution permits: taking the market microstructure into account

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  • GERMAIN, Marc
  • VAN STEENBERGHE, Vincent

Abstract

This paper analyses how the way emission permits are traded -their market microstructure-impacts the optimal policy to be adopted by the environmental agency. The microstructure used is one of a quote driven market type, which characterizes many financial markets: market makers act as intermediaries for trading the permits by setting a ask price and a bid price. The possibility of permit banking is also introduced in our dynamic two-period model. We show that when the market makers and the agency do not know the technology of the producers with certainty, a positive spread may be set by market makers and that, under some conditions, banking increases the expected welfare given this market microstructure. If such a microstructure takes place or is organised on markets for pollution permits, we recommend to allow for banking (a) if the marginal willingness to pay for the environment increases much over time, (b) if the pollutant is rather a stock than a flow one, and/or (c) if the incomplete information faced by the intermediaries and by the agency is severe. In the first period, the environmental agency will then have to define and allocate a larger amount of permits than if banking is not allowed, but a lower or a same amount of permits in the second period.

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  • GERMAIN, Marc & VAN STEENBERGHE, Vincent, 2001. "Optimal policy tradable and bankable pollution permits: taking the market microstructure into account," CORE Discussion Papers 2001035, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  • Handle: RePEc:cor:louvco:2001035
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    File URL: https://uclouvain.be/en/research-institutes/immaq/core/dp-2001.html
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    References listed on IDEAS

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    1. Hahn, Robert W., 1982. "Market Power and Transferable Property Rights," Working Papers 402, California Institute of Technology, Division of the Humanities and Social Sciences.
    2. Daniel Phaneuf & Till Requate, 2002. "Incentives for Investment in Advanced Pollution Abatement Technology in Emission Permit Markets with Banking," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 22(3), pages 369-390, July.
    3. Kling, Catherine & Rubin, Jonathan, 1997. "Bankable permits for the control of environmental pollution," Journal of Public Economics, Elsevier, vol. 64(1), pages 101-115, April.
    4. Germain, Marc & Lovo, Stefano & Vansteenberghe, Vincent, 2000. "De l'importance de la microstructure d'un marché de permis de polluer," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2000010, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    5. Bruno Biais, 1990. "Formation des prix sur les marchés de contrepartie. Une synthèse de la littérature récente," Revue Économique, Programme National Persée, vol. 41(5), pages 755-788.
    6. Montero, Juan-Pablo, 1998. "Marketable pollution permits with uncertainty and transaction costs," Resource and Energy Economics, Elsevier, vol. 20(1), pages 27-50, March.
    7. Schennach, Susanne M., 2000. "The Economics of Pollution Permit Banking in the Context of Title IV of the 1990 Clean Air Act Amendments," Journal of Environmental Economics and Management, Elsevier, vol. 40(3), pages 189-210, November.
    8. 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.
    9. Hagem, Cathrine & Westskog, Hege, 1998. "The Design of a Dynamic Tradeable Quota System under Market Imperfections," Journal of Environmental Economics and Management, Elsevier, vol. 36(1), pages 89-107, July.
    10. Cronshaw, Mark B & Brown-Kruse, Jamie, 1996. "Regulated Firms in Pollution Permit Markets with Banking," Journal of Regulatory Economics, Springer, vol. 9(2), pages 179-189, March.
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