Risk Sharing in Coasian Contracts

Abstract

The Coase Theorem is analyzed in a setting in which pollution damages are a stochastic function of emissions and of natural environmental variability (e.g., weather). When pollution damages are stochastic, emissions create financial risks. Pollution levels allowed under Coasian contracts then in general depend on agents' risk appetites, and on the initial configuration of property rights and bargaining power. In this case, resource allocation decisions are not separable from the legal institutions that allocate risks, nor from the financial institutions that facilitate risk transfer. In particular, improvements in environmental risk markets generally induce greater levels of pollution.

Keywords: Environment, risk, Coase Theorem

JEL Classification: Q2, K1, D8