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Emissions trading with rolling horizons

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  • Quemin, Simon
  • Trotignon, Raphaël

Abstract

We develop an emission permits trading model where covered firms can (1) utilize rolling planning horizons to deal with uncertainty and (2) exhibit bounded responsiveness to supply-side control policies. We calibrate the model to reproduce annual market outcomes in the EU ETS over 2008–2018 and show that a rolling finite horizon reconciles the banking dynamics with discount rates implied by futures contracts’ yield curves. It also replicates the price dynamics well compared to a standard infinite horizon, including the new price regime induced by the 2018 market reform. We then use our calibrated model to decompose the impacts of the 2018 reform's design elements, quantify how they hinge on the firms’ horizon and responsiveness, and highlight important implications for policy design. For instance, when firms utilize rolling horizons, the Market Stability Reserve can improve effectiveness by frontloading abatement efforts and induce lower cumulative emissions compared to an infinite horizon.

Suggested Citation

  • Quemin, Simon & Trotignon, Raphaël, 2021. "Emissions trading with rolling horizons," LSE Research Online Documents on Economics 113518, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:113518
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    bounded rationality; emissions trading; EU ETS; rolling horizon; supply-side policies; Grantham Foundation for the Protection of the Environment; the UK Economic 70More generally; since there is no economic rationale for regulating the firms’ intertemporal use of permits (i.e. is permit use frontloaded or backloaded compared to MSR thresholds?); it would be worth studying how the MSR behaves relative to optimal supply adjustment mechanisms; e.g. à la Laffont & Tirole (1996). 40 and Social Research Council (ESRC) through the Centre for Climate Change Economics and Policy;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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