Experimental comparison between markets on dynamic permit trading and investment in irreversible abatement with and without nonregulated companies
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Working Paper 41
Abstract
This paper examines the investment strategies of regulated companies in abatement technologies, market participants’ trading behaviours, and the liquidity level in an inter-temporal cap and trade market using laboratory experiments.
The experimental analysis is performed under varying market structures: the exclusive presence of regulated companies; the inclusion of subjects not liable for compliance with environmental regulations; the availability of plain vanilla options.
In line with theoretical models on irreversible abatement investment, the first experiment shows that regulated companies trade permits at a premium.
At the same time, the existence of a strict enforcement structure effectively prompts investments in new technologies.
The second experiment shows that the presence of non-regulated companies adds liquidity to the market and does not increase price volatility.
The last experiment enables us to investigate the impact of the presence of cash-settled options contracts on the trading strategies of regulated companies. Their expected emissions appears to play a significant role in the choice of their options strategy.
Marc Chesney, Luca Taschini and Mei Wang