Publication: Rate of Return Regulation and Emission Permits Trading under Uncertainty
This paper analyzes the dynamic effects of rate-of-return regulation on firms’ emissions compliance behavior when the price of emissions permits is uncertain. The paper shows that uncertainty regarding the price of permits would motivate a regulated firm to adopt a more self-sufficient strategy and would reduce the cost-effectiveness of emission allowance trading. When allowance transactions are treated as capital investments, uncertainty could reverse the classic Averch-Johnson effect, so that a regulated firm would purchase fewer permits in the ex ante period than its unregulated counterpart. These results are driven by the asymmetric impact of a price change on the expected marginal value of allowances under rate-of-return regulation. A wider variation in the permit price and a decline in the regulated rate of return would amplify the asymmetry. These results have implications for the efficiency of the proposed global carbon trading system.
“Zhang, Fan; Huang, Tao. 2015. Rate of Return Regulation and Emission Permits Trading under Uncertainty. Policy Research Working Paper;No. 7343. © World Bank, Washington, DC. http://openknowledge.worldbank.org/handle/10986/22220 License: CC BY 3.0 IGO.”
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