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

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  • Baldursson, Fridrik M.
  • Fehr, Nils-Henrik M. von der

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.

Suggested Citation

  • Baldursson, Fridrik M. & Fehr, Nils-Henrik M. von der, 2009. "Price volatility and risk exposure: on the interaction of quota and product markets," MPRA Paper 14994, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:14994
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    References listed on IDEAS

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    Cited by:

    1. Bontems, Philippe & Nauges, Céline, 2017. "Production choices with water markets: The role of initial allocations and forward trading," TSE Working Papers 17-812, Toulouse School of Economics (TSE).
    2. Halvor Storrøsten, 2014. "Prices Versus Quantities: Technology Choice, Uncertainty and Welfare," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 59(2), pages 275-293, October.
    3. Simon Quemin, 2016. "Intertemporal abatement decisions under ambiguity aversion in a cap and trade," Working Papers 1604, Chaire Economie du climat.

    More about this item

    Keywords

    regulation; effluent taxes; tradable quotas; uncertainty; risk aversion; environmental management;

    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 - - Micro-Based Behavioral Economics
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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