Working Paper: NBER ID: w19780
Authors: Stephen Holland; Andrew J. Yates
Abstract: We analyze a novel method for improving the efficiency of pollution permit markets by optimizing the way in which emissions are exchanged through trade. Under full-information, it is optimal for emissions to exchange according to the ratio of marginal damages. However, under a canonical model with asymmetric information between the regulator and the sources of pollution, we show that these marginal damage trading ratios are generally not optimal, and we show how to modify them to improve efficiency. We calculate the optimal trading ratios for a global carbon market and for a regional nitrogen market. In these examples, the gains from using optimal trading ratios rather than marginal damage trading ratios range from substantial to trivial, which suggests the need for careful consideration of the structure of asymmetric information when designing permit markets.
Keywords: pollution permits; trading ratios; asymmetric information; market efficiency
JEL Codes: D82; H23; Q53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal trading ratios (F16) | marginal damage trading ratios (F16) |
| asymmetric information (D82) | inefficiencies in trading ratios (F12) |
| optimal trading ratios (F16) | efficiency gains (D61) |
| asymmetric information about abatement costs (D82) | deadweight loss (H21) |
| uncertainty in abatement costs (Q52) | optimal trading ratios (F16) |