Soft and Hard Price Collars in a Cap-and-Trade System: A Comparative Analysis
Resources for the Future Discussion Paper 10-27-REV
34 Pages Posted: 19 May 2010 Last revised: 10 Jun 2011
Date Written: May 7, 2010
We use a stochastic dynamic framework to compare price collars (price ceilings and floors) in a cap-and-trade system with uncertainty in the level of baseline emissions and costs. We consider soft collars, which provide limited volume of additional emission allowances (a reserve) at the price ceiling, and hard collars, which provide an unlimited supply of additional allowances, thereby preventing allowance prices from exceeding the price ceiling. Conversely, allowances are removed from the market if prices fall to the floor. We find that increasing the size of the reserve strictly lowers expected net present values of compliance costs; however, there is a diminishing effect as the allowance reserve is expanded. Most of the expected cost savings are achieved with a modest reserve. Consequently, a rather limited soft price collar could provide considerable assurance about cost while preventing the possibility that emissions could spiral out of control.
Keywords: climate change, cap-and-trade, price collars, stochastic dynamic programming
JEL Classification: Q54, Q58, C61
Suggested Citation: Suggested Citation