Efficiency and dependency in a network of linked permit markets

Juha Itkonen

No 20/2017, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We model a network of linked permit markets to examine efficiency and dependencies between the markets in a competitive equilibrium. Links enable the participants of one emissions trading system to use the permits of another system. To improve the cost-efficiency of the international policy architecture, the Paris climate agreement set out a framework for linking local policies. International trade in permits reduces costs by merging markets, but in a large network it is generally not obvious which markets end up linked in the equilibrium. Also, indirect links might allow foreign regulators to undermine domestic policy outcomes. We apply graph theory to study dependencies between markets and to determine how the network is partitioned into separate market areas. Our main theorem characterizes the dependency structure of the equilibrium in an exogenous trading network. We show that markets merge when they are connected by a particular pattern of links. The results help to identify potential sources of both cost reductions and foreign interference, and to secure the efficiency of climate change policies.

JEL-codes: D41 F13 L14 Q54 Q58 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2017_020

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