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Price Volatility and Risk Exposure: On the Interaction of Quota and Product Markets

35 Pages Posted: 25 Apr 2009  

Fridrik M. Baldursson

Reykjavik University

Nils-Henrik M. von der Fehr

University of Oslo - Department of Economics

Date Written: April 22, 2009

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.

Keywords: regulation, effluent taxes, tradable quotas, uncertainty, risk aversion, environmental management

JEL Classification: D81, D9, H23, L51, Q28, Q38

Suggested Citation

Baldursson, Fridrik M. and von der Fehr, Nils-Henrik M., Price Volatility and Risk Exposure: On the Interaction of Quota and Product Markets (April 22, 2009). Available at SSRN: https://ssrn.com/abstract=1394342 or http://dx.doi.org/10.2139/ssrn.1394342

Fridrik M. Baldursson (Contact Author)

Reykjavik University ( email )

Ofanleiti 2
Reykjavik, 103
Iceland
+3545996200 (Phone)

Nils-Henrik M. Von der Fehr

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47 22 85 51 40 (Phone)
+47 22 85 50 35 (Fax)

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