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Optimal Trading Ratios for Pollution Permit Markets

Stephen Holland () and Andrew Yates

No 19780, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: D82 H23 Q53 (search for similar items in EconPapers)
Date: 2014-01
New Economics Papers: this item is included in nep-cta, nep-ene, nep-env, nep-reg and nep-res
Note: EEE
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Published as Holland, Stephen P. & Yates, Andrew J., 2015. "Optimal trading ratios for pollution permit markets," Journal of Public Economics, Elsevier, vol. 125(C), pages 16-27.

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