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Emissions trading with rolling horizons

Simon Quemin and Raphael Trotignon

Journal of Economic Dynamics and Control, 2021, vol. 125, issue C

Abstract: We develop an emission permits trading model where covered firms can (1) utilize rolling planning horizons to deal with uncertainty and (2) exhibit bounded responsiveness to supply-side control policies. We calibrate the model to reproduce annual market outcomes in the EU ETS over 2008–2018 and show that a rolling finite horizon reconciles the banking dynamics with discount rates implied by futures contracts’ yield curves. It also replicates the price dynamics well compared to a standard infinite horizon, including the new price regime induced by the 2018 market reform. We then use our calibrated model to decompose the impacts of the 2018 reform’s design elements, quantify how they hinge on the firms’ horizon and responsiveness, and highlight important implications for policy design. For instance, when firms utilize rolling horizons, the Market Stability Reserve can improve effectiveness by frontloading abatement efforts and induce lower cumulative emissions compared to an infinite horizon.

Keywords: Emissions trading; Rolling horizon; Bounded rationality; Supply-side policies; EU ETS (search for similar items in EconPapers)
JEL-codes: D25 D81 E63 H32 Q58 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jedc.2021.104099

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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