Designing Pollution Markets

Maria-Eugenia Sanin (University of Evry-Val d’Essonne)



Firms producing a polluting good that is subject to environmental regulation based on tradable emission permits, base their production, pollution abatement and permits trading decisions on their expectations about permits price and goods’ market conditions.
Firms can only rely on their permits price expectations for decision making when the market for tradable permits is stable (i.e. low volatility) and characterized by a transparent and efficient price formation mechanism. In the first part of my PhD thesis I assess the determinants of short-run price dynamics and market stability, as well as, the market microstructure of tradable permits markets as a function of (and in relation with) the underlying goods market. The latter analysis is undertaken in the first chapter using transactions data for the U.S. Acid Rain market over the period 1995-2005, cross-referenced with regional electricity market conditions over the same period. The determinants of short-run price dynamics and market stability are analyzed in a second chapter: using the December 2008 future prices registered in the EU emission trading scheme over the period 2005-2007, I find that the release of information regarding the pollution constraints imposed by the EU commission undermine market stability.
In the second part of my PhD thesis I complete the assessment of tradable permits markets by studying production, abatement and trading decisions themselves. With this purpose, I modify the traditional successive market theory to account for the specific characteristics of the technological linkage between a permits market (upstream) and an oligopolistic goods market (downstream). In this context I reveal how strategic firms are able to manipulate the permits price and price path, as well as, which market design should be implemented to preserve efficiency and increase total welfare.