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Intertemporal Abatement Decisions under Ambiguity Aversion in a Cap and Trade

Simon Quemin

No 2017.06, Working Papers from FAERE - French Association of Environmental and Resource Economists

Abstract: We study intertemporal abatement decisions by an ambiguity averse firm covered under a cap and trade. Ambiguity aversion is introduced to account for the prevalence of regulatory uncertainty in existing cap-and-trade schemes. Ambiguity bears on both the future permit price and the firm's demand for permits. Ambiguity aversion drives equilibrium choices away from intertemporal efficiency and induces two effects: a pessimistic distortion of beliefs that overemphasises ‘detrimental’ outcomes and a shift in the effective discount factor. Permit allocation is non neutral and the firm's intertemporal abatement decisions do not solely depend on expected future permit prices, but also on its own expected future market position. In particular, pessimism leads the expected net short (resp. long) firm to overabate (resp. underabate) early on relative to intertemporal efficiency. We show that there is a general incentive for early overabatement and that it is more pronounced under auctioning that under free allocation.

Keywords: Emissions trading; Regulatory uncertainty; Permit banking; Ambiguity aversion (search for similar items in EconPapers)
JEL-codes: D81 D92 Q58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ene and nep-upt
Date: 2017-05
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http://faere.fr/pub/WorkingPapers/Quemin_FAERE_WP2017.06.pdf First version, 2017 (application/pdf)

Related works:
Working Paper: Intertemporal abatement decisions under ambiguity aversion in a cap and trade (2017) Downloads
Working Paper: Intertemporal abatement decisions under ambiguity aversion in a cap and trade (2016) Downloads
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