Linking Permit Markets Multilaterally

By Baran Doda, Simon Quemin, Luca Taschini

Abstract

We develop a general model to analyze multilateral linkages between permit markets and characterize the determinants, magnitude and distribution of efficiency gains in an arbitrary linkage group. We decompose these gains into gains in the group’s internal bilateral linkages, quantify those that are attributable to effort and risk sharing, and characterize individual preferences over possible linkage groups. We also analyze the relationship between autarky and linking prices, and show linkage reduces price volatility on average. In a quantitative application calibrated to the Paris Agreement pledges of the power sectors in Canada, continental Europe, South Korea, the UK and the USA, we show linking can generate gains of up to $370 million (constant 2005US$) per year relative to autarky. Focusing on linkage groups with two and three members which are themselves not linked, we find that maximum aggregate gains decline by $43-178 million.