Emissions Trading with Shares and Coupons when Control over Discharges is Uncertain

Abstract

"Two important decisions in designing markets for tradable emissions permits are whether to allow banking and whether to allow trading in entitlements to future permits. Banking is predicted to reduce price instability when firms trade in a reconciliation market after the quantity of emissions has been determined. Tradable entitlements ('shares') are a common feature in proposals for emissions trading in Canada. We conduct a laboratory experiment to investigate how bankable coupons and tradable shares affect efficiency and prices under alternative conditions of certainty and uncertainty. Cognitive demands on the subjects are reduced by computerized advice on the optimal allocation of coupons across periods and the implied marginal values of coupons and shares. Banking, share trading and uncertainty conditions are introduced in a complete factorial design with 3 observations per cell. High efficiencies are observed across all treatments. Substantial price instability is observed when control of emissions is uncertain. Coupon Banking reduces this instability. Share trading reduces trading volumes, increases price stability and improves efficiency, particularly when combined with banking."