Working Paper: CEPR ID: DP13343
Authors: Estelle Cantillon; Aurlie Slechten
Abstract: A key policy argument in favor of emissions markets (relative to command-and-control types ofregulation) is their ability to aggregate dispersed information and generate price signals to guiderms' trading and abatement decisions. We investigate this argument in a multi-period modelwhere rms receive noisy private signals about their current period emissions and privatelyobserve their previous period emissions before this information is made public to the rest ofthe market. Firms respond to information by trading and abating emissions. We show thatthere exists a rational expectations equilibrium that fully aggregates rms' private information,justifying the policy argument in favor of emissions markets, in the absence of other frictions. Wealso derive predictions about how prices should be reacting to new private or public informationand show that the possibility of abatement dampens the impact of shocks on prices. Finally,we show that the information aggregation result breaks down if rms' abatement costs are alsoprivate information.
Keywords: information aggregation; efficient market hypothesis; price formation; emissions trading
JEL Codes: G14; D83; D84; D85; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Private information about emissions (Q58) | Trading behavior (G40) |
| Trading behavior (G40) | Equilibrium prices (D41) |
| Equilibrium prices (D41) | Allocation of emissions (Q52) |
| Possibility of abatement (H26) | Price behavior in response to new information (D83) |
| Private information about abatement costs (Q52) | Breakdown in information aggregation (D89) |