Emissions trading with rolling horizons

Simon Quemin and Raphaël Trotignon

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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: bounded rationality; emissions trading; EU ETS; rolling horizon; supply-side policies; Grantham Foundation for the Protection of the Environment; the UK Economic 70More generally; since there is no economic rationale for regulating the firms’ intertemporal use of permits (i.e. is permit use frontloaded or backloaded compared to MSR thresholds?); it would be worth studying how the MSR behaves relative to optimal supply adjustment mechanisms; e.g. à la Laffont & Tirole (1996). 40 and Social Research Council (ESRC) through the Centre for Climate Change Economics and Policy (search for similar items in EconPapers)
JEL-codes: D81 E63 H32 Q58 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2021-04-01
New Economics Papers: this item is included in nep-ene and nep-env
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Citations: View citations in EconPapers (19)

Published in Journal of Economic Dynamics and Control, 1, April, 2021, 125. ISSN: 0165-1889

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http://eprints.lse.ac.uk/113518/ Open access version. (application/pdf)

Related works:
Journal Article: Emissions trading with rolling horizons (2021)
Working Paper: Emissions trading with rolling horizons (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:113518

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