The European Union Emissions Trading System and the Market Stability Reserve: Optimal Dynamic Supply Adjustment

26 Pages Posted: 9 Jun 2015

See all articles by Sascha Kollenberg

Sascha Kollenberg

University of Duisburg-Essen

Luca Taschini

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment; University of Verona - Department of Economics

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Date Written: May 31, 2015

Abstract

The supply of allowances in the European Union Emissions Trading System is determined within a rigid allocation programme. A reform of the EU ETS intends to make allowances allocation flexible and contingent on the state of the system. We model the emissions market under adjustable allowance supply in a stochastic partial equilibrium framework and obtain closed form solutions for its dynamics. The model considers a supply control mechanism contingent on the number of allocated and unused allowances, as suggested by the European Commission. We derive analytical dependencies between the allowance allocation adjustment rate and the market equilibrium dynamics, which allows us to represent the quantity thresholds as quantiles for the number of allocated and unused allowances. Finally, we present an analytical tool for the selection of an optimal adjustment rate under both risk-neutrality and risk-aversion. We thereby provide an analytical foundation for the regulator's decision-making in the context of the EU ETS reform and give a novel perspective on the mechanism's overall design.

Keywords: EU ETS reform, policy design, responsiveness, resilience, supply management mechanism, risk-aversion

Suggested Citation

Kollenberg, Sascha and Taschini, Luca, The European Union Emissions Trading System and the Market Stability Reserve: Optimal Dynamic Supply Adjustment (May 31, 2015). CESifo Working Paper Series No. 5380. Available at SSRN: https://ssrn.com/abstract=2615742

Sascha Kollenberg

University of Duisburg-Essen ( email )

Universit├Ątsstra├če 12
Essen, 45141
Germany

Luca Taschini (Contact Author)

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment ( email )

Houghton Street
London, WC2A 2AE
Great Britain

University of Verona - Department of Economics ( email )

Via Cantarane 24
Verona, Verona 37129
Italy

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