, Volume 17, Issue 4, pp 325-343
Date: 03 Nov 2009

Environmental Economics and Modeling Marketable Permits

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Abstract

This paper reviews fundamental concepts in environmental economics and explores theoretical results regarding the choice of the key policy instruments for the control of externalities: taxes, subsidies and marketable permits. The paper explains why today market mechanisms are increasingly being used as a tool for allocating unpriced rights and scarce resources. We survey how significant market imperfections, a pre-existing regulatory environment and concentration in both permit and output markets can impede the proper functioning of a permit system. The main factors that affect the effectiveness of marketable permits are then discussed. Given the importance of understanding the emission permit price formation, we overview recent attempts at developing valid price models for emission permits, taking into account banking and borrowing opportunities, pollution abatement measures, strategic trading interactions and the presence of asymmetric information in the permit market.

Part of the author’s research was supported by the University Research Priority Program “Finance and Financial Markets” and by the National Centre of Competence in Research “Financial Valuation and Risk Management” (NCCR FINRISK), research instruments, respectively, of the University of Zürich and of the Swiss National Science Foundation.
L. Taschini would like to thank Federica Buricco, Takanobu Kosugi and the participants of the “8th Ritsumeikan International Symposium on Stochastic Processes and Application to Mathematical Finance—8th Columbia Jafee Conference” (Kyoto, Japan) for their helpful discussions and comments. The financial support of the Heiwa Nakajima Foundation to the Special Session on Environmental Finance is gratefully acknowledged.