Optimal Trading Ratios for Pollution Permit Markets

54 Pages Posted: 7 Jan 2014 Last revised: 6 Oct 2014

See all articles by Stephen P. Holland

Stephen P. Holland

University of California, Berkeley - Energy Institute; University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics

Andrew Yates

University of North Carolina (UNC) at Chapel Hill - Department of Economics

Date Written: January 2014

Abstract

We analyze a novel method for improving the efficiency of pollution permit markets by optimizing the way in which emissions are exchanged through trade. Under full-information, it is optimal for emissions to exchange according to the ratio of marginal damages. However, under a canonical model with asymmetric information between the regulator and the sources of pollution, we show that these marginal damage trading ratios are generally not optimal, and we show how to modify them to improve efficiency. We calculate the optimal trading ratios for a global carbon market and for a regional nitrogen market. In these examples, the gains from using optimal trading ratios rather than marginal damage trading ratios range from substantial to trivial, which suggests the need for careful consideration of the structure of asymmetric information when designing permit markets.

Suggested Citation

Holland, Stephen P. and Yates, Andrew, Optimal Trading Ratios for Pollution Permit Markets (January 2014). NBER Working Paper No. w19780. Available at SSRN: https://ssrn.com/abstract=2375478

Stephen P. Holland (Contact Author)

University of California, Berkeley - Energy Institute ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics ( email )

401 Bryan Building
Greensboro, NC 27402-6179
United States

Andrew Yates

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Chapel Hill, NC 27599
United States

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