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Risk Aversion and Compliance in Markets for Pollution Control

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  • John K. Stranlund

    () (Department of Resource Economics, University of Massachusetts Amherst)

Abstract

This paper examines the effects of risk aversion on compliance choices in markets for pollution control. A firm’s decision to be compliant or not is independent of its manager’s risk preference. However, noncompliant firms with risk averse managers will have lower violations than otherwise identical firms with risk neutral managers. The violations of noncompliant firms with risk averse managers are independent of differences in their benefits from emissions and their initial allocations of permits if and only if their managers’ utility functions exhibit constant absolute risk aversion. However, firm-level characteristics do impact violation choices when managers have coefficients of absolute risk aversion that are increasing or decreasing in profit levels. Finally, in the equilibrium of a market for emissions rights with widespread noncompliance, risk aversion is associated with higher permit prices, better environmental quality, and lower aggregate violations.

Suggested Citation

  • John K. Stranlund, 2006. "Risk Aversion and Compliance in Markets for Pollution Control," Working Papers 2006-2, University of Massachusetts Amherst, Department of Resource Economics.
  • Handle: RePEc:dre:wpaper:2006-2
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    File URL: http://courses.umass.edu/resec/workingpapers/documents/resecworkingpaper2006-2.pdf
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    References listed on IDEAS

    as
    1. Stranlund, John K & Chavez, Carlos A, 2000. "Effective Enforcement of a Transferable Emissions Permit System with a Self-Reporting Requirement," Journal of Regulatory Economics, Springer, vol. 18(2), pages 113-131, September.
    2. Garvie, Devon & Keeler, Andrew, 1994. "Incomplete enforcement with endogenous regulatory choice," Journal of Public Economics, Elsevier, vol. 55(1), pages 141-162, September.
    3. Carolos Chavez & John Stanlund, 2003. "Enforcing Transferable Permit Systems in the Presence of Market Power," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 25(1), pages 65-78, May.
    4. Carlos Chavez & Hugo Salgado, 2005. "Individual Transferable Quota Markets under Illegal Fishing," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 31(3), pages 303-324, July.
    5. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
    6. Stranlund, John K. & Dhanda, Kanwalroop Kathy, 1999. "Endogenous Monitoring and Enforcement of a Transferable Emissions Permit System," Journal of Environmental Economics and Management, Elsevier, vol. 38(3), pages 267-282, November.
    7. Macho-Stadler, Ines & Perez-Castrillo, David, 2006. "Optimal enforcement policy and firms' emissions and compliance with environmental taxes," Journal of Environmental Economics and Management, Elsevier, vol. 51(1), pages 110-131, January.
    8. Harford, Jon D., 1978. "Firm behavior under imperfectly enforceable pollution standards and taxes," Journal of Environmental Economics and Management, Elsevier, vol. 5(1), pages 26-43, March.
    9. John Stranlund & Christopher Costello & Carlos Chávez, 2005. "Enforcing Emissions Trading when Emissions Permits are Bankable," Journal of Regulatory Economics, Springer, vol. 28(2), pages 181-204, September.
    10. Malik, Arun S., 1990. "Markets for pollution control when firms are noncompliant," Journal of Environmental Economics and Management, Elsevier, vol. 18(2), pages 97-106, March.
    11. Keeler, Andrew G., 1991. "Noncompliant firms in transferable discharge permit markets: Some extensions," Journal of Environmental Economics and Management, Elsevier, vol. 21(2), pages 180-189, September.
    12. Malik, Arun S., 2002. "Further Results on Permit Markets with Market Power and Cheating," Journal of Environmental Economics and Management, Elsevier, vol. 44(3), pages 371-390, November.
    13. Agnar Sandmo, 2002. "Efficient Environmental Policy with Imperfect Compliance," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 23(1), pages 85-103, September.
    14. Hatcher, Aaron, 2005. "Non-compliance and the quota price in an ITQ fishery," Journal of Environmental Economics and Management, Elsevier, vol. 49(3), pages 427-436, May.
    15. Murphy, James J. & Stranlund, John K., 2006. "Direct and market effects of enforcing emissions trading programs: An experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 61(2), pages 217-233, October.
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    Cited by:

    1. Restiani, Phillia & Betz, Regina, 2010. "A Theoretical Model of Optimal Compliance Decisions under Different Penalty Designs in Emissions Trading Markets," Research Reports 107585, Australian National University, Environmental Economics Research Hub.
    2. Fatih Karanfil, 2011. "Environmental regulation in the presence of unrecorded economy," International Economics, CEPII research center, issue 126-127, pages 91-108.
    3. Yano, Yuki & Blandford, David, 2008. "Use of Penalties and Rewards in Agri-Environmental Policy," 82nd Annual Conference, March 31 - April 2, 2008, Royal Agricultural College, Cirencester, UK 36873, Agricultural Economics Society.

    More about this item

    Keywords

    Emissions Trading; Compliance; Enforcement; Risk Aversion;

    JEL classification:

    • 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

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