FEEM working papers "Note di lavoro" series
2015 .048

Optimal Management of Markets for Bankable Emission Permits


Autori: Jussi Lintunen, Olli-Pekka Kuusela
Serie: Climate Change and Sustainable Development
Editor: Carlo Carraro
Parole chiave: Cap and Trade, Climate Change, Business Cycle, Second Best, Prices vs. Quantities
Numero JEL: E32, Q54, Q58

Abstract

We examine the optimal management of emission permit markets when banking but not borrowing of permits is allowed. The regulator maximizes expected social welfare through an optimal allocation rule in an infinite horizon setting. The policy is second-best as the emission cap is set before the uncertainty about the current state of the economy is resolved. In this setting, the role of banking is to decrease the regulator’s risk as it generates an endogenous price floor in the permit markets. We show that the regulator’s optimal policy adjusts the emissions cap irrespective of the existing number of permits in the bank, with the implication that the regulator neutralizes the effect of the existing bank on future permit prices. We derive the optimality conditions for the second-best emission cap with banking and solve the model analytically in the case of IID shocks. Our results show that the discount factor together with the slopes of the marginal damages and benefits determine the welfare gains from allowing baking of permits. Finally, to address the current state of the EU Emission Trading Scheme (EU ETS) and guide the design of future permit markets, we solve the model numerically with persistent shock process and show that the optimal emission cap is positively correlated with business cycles, meaning that during downturns the regulator should tighten the cap. The expected emissions and permit prices also correlate positively with economic activity.

***
Suggested citation: Lintunen, J., O.-P. Kuusela, (2015), 'Optimal Management of Markets for Bankable Emission Permits', Nota di Lavoro 48.2015, Milan, Italy: Fondazione Eni Enrico Mattei

Download file
Scarica il file PDF

FEEM Newsletter

Iscriviti per rimanere aggiornato.

I Suoi dati saranno trattati dalla Fondazione Eni Enrico Mattei. – Titolare del trattamento – per ricevere via posta elettronica la newsletter della Fondazione. Il conferimento dell’indirizzo e-mail è necessario alla fornitura del servizio. La invitiamo a consultare la Privacy Policy per ottenere maggiori informazioni a tutela dei Suoi diritti.

Questo Sito utilizza cookie tecnici e analytics, nonché consente l’invio di cookie di profilazione di terze parti.
Chiudendo questo banner o comunque proseguendo la navigazione sul Sito manifesti il tuo consenso all’uso dei cookie. Per ulteriori informazioni e per esprimere scelte selettive in ordine all’uso dei cookie vedi la   Cookie PolicyOk