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

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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File URL: http://econ.ccps.virginia.edu/RePEc_docs/ceps_docs/ab32_banking_7-13.pdf
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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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