Pollution permits, strategic trading and dynamic technology adoption


Working Paper 45

Abstract

This paper analyses the dynamic incentives for technology adoption under a transferable permits system, which allows for strategic trading on the permit market.

Initially, firms can invest both in low-emitting production technologies and trade permits. In the model, technology adoption and allowance price are generated endogenously and are interdependent. It is shown that the non-cooperative permit trading game possesses a pure-strategy Nash equilibrium, where the allowance value reflects the level of uncovered pollution (demand), the level of unused allowances (supply), and the technological status.

These conditions are also satisfied when a price support instrument, which is contingent on the adoption of the new technology, is introduced. Numerical investigation confirms that this policy generates a floating price floor for the allowances, and it restores the dynamic incentives to invest.

Given that this policy comes at a cost, a criterion for the selection of a self-financing policy (based on convex risk measures) is proposed and implemented.

Santiago Moreno-Bromberg and Luca Taschini