Information Aggregation in Emissions Markets with Abatement

34 Pages Posted: 3 Dec 2018

See all articles by Estelle Cantillon

Estelle Cantillon

Free University of Brussels (VUB/ULB) - ECARES; Centre for Economic Policy Research (CEPR)

Aurélie Slechten

Lancaster University

Date Written: November 2018

Abstract

A key policy argument in favor of emissions markets (relative to command-and-control types of regulation) is their ability to aggregate dispersed information and generate price signals to guide firms' trading and abatement decisions. We investigate this argument in a multi-period model where firms receive noisy private signals about their current period emissions and privately observe their previous period emissions before this information is made public to the rest of the market. Firms respond to information by trading and abating emissions. We show that there exists a rational expectations equilibrium that fully aggregates firms' private information, justifying the policy argument in favor of emissions markets, in the absence of other frictions. We also derive predictions about how prices should be reacting to new private or public information and show that the possibility of abatement dampens the impact of shocks on prices. Finally, we show that the information aggregation result breaks down if firms' abatement costs are also private information.

Keywords: Efficient Market Hypothesis, Emissions Trading, information aggregation, Price Formation

JEL Classification: D83, D84, D85, G14, Q58

Suggested Citation

Cantillon, Estelle and Slechten, Aurélie, Information Aggregation in Emissions Markets with Abatement (November 2018). CEPR Discussion Paper No. DP13343, Available at SSRN: https://ssrn.com/abstract=3295001

Estelle Cantillon (Contact Author)

Free University of Brussels (VUB/ULB) - ECARES ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
B-1050 Brussels
Belgium
+32 2 650 3840 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Aurélie Slechten

Lancaster University ( email )

Lancaster LA1 4YX
United Kingdom

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