Risk Aversion and Compliance in Markets for Pollution Control

21 Pages Posted: 8 Sep 2006

See all articles by John Stranlund

John Stranlund

University of Massachusetts at Amherst - College of Natural Resources & the Environment - Department of Resource Economics

Date Written: September 2006

Abstract

This paper examines the effects of risk aversion on compliance choices in markets for pollution control. A firm's decision to be compliant or not is independent of its manager's risk preference. However, noncompliant firms with risk averse managers will have lower violations than otherwise identical firms with risk neutral managers. The violations of noncompliant firms with risk averse managers are independent of differences in their benefits from emissions and their initial allocations of permits if and only if their managers' utility functions exhibit constant absolute risk aversion. However, firm-level characteristics do impact violation choices when managers have coefficients of absolute risk aversion that are increasing or decreasing in profit levels. Finally, in the equilibrium of a market for emissions rights with widespread noncompliance, risk aversion is associated with higher permit prices, better environmental quality, and lower aggregate violations.

Keywords: Emissions Trading, Compliance, Enforcement, Risk Aversion

JEL Classification: L51, Q28

Suggested Citation

Stranlund, John, Risk Aversion and Compliance in Markets for Pollution Control (September 2006). Available at SSRN: https://ssrn.com/abstract=928963 or http://dx.doi.org/10.2139/ssrn.928963

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University of Massachusetts at Amherst - College of Natural Resources & the Environment - Department of Resource Economics ( email )

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