Experimental Comparison between Markets on Dynamic Permit Trading and Investment in Irreversible Abatement with and without Non-Regulated Companies

Abstract

This paper examines the investment strategies of compliance companies in irreversible abatement technologies and the environmental achievements of the system in an inter-temporal cap-and-trade market using laboratory experiments. The experimental analysis is performed under varying market structures: firstly, in a market that is exclusive to compliance companies and subsequently, in a market that is open to both compliance and non-compliance entities. In line with theoretical models on irreversible abatement investment, the paper shows that regulated companies trade permits at a premium. Also, steep per unit penalties for excess emissions prompt early investments in irreversible abatement technologies. Further, the paper shows that by contributing to the permit demand and supply, non-compliance companies (i) enhance the exchange of permits, helping the system to achieve a zero-excess permit position, (ii) increase the price levels, but has no apparent effect on price variability.

Keywords: Irreversible Abatement, Stochastic Emissions, Dynamic Trading, Participation Restrictions, Non-compliance Entities.

JEL Classification: Q50, C02, C91, D40