Price Volatility and Risk Exposure: On the Interaction of Quota and Product Markets
- 192 Downloads
We consider an industry with firms that produce a final good emitting pollution to different degree as a side effect. Pollution is regulated by a tradable quota system where some quotas may have been allocated at the outset, i.e. before the quota market is opened. We study how volatility in quota price affects firm behaviour, taking into account the impact of quota price on final-good price. The impact on the individual firm differs depending on how polluting it is—whether it is ‘clean’ or ‘dirty’—and whether it has been allocated quotas at the outset. In the absence of long-term or forward contracting, a grandfathering regime—where clean firms are allocated no quotas and dirty firms are allocated quotas for a part of their emissions—minimizes the impact on firm behavior relative to a risk-neutral benchmark.With forward contracts and in the absence of wealth effects initial quota allocation has no effect on firm behaviour. Allowing for abatement does not change the qualitative nature of our results.
KeywordsRegulation Effluent taxes Tradable quotas Uncertainty Risk aversion Environmental management
JEL ClassificationD81 D9 H23 L51 Q28 Q38
Unable to display preview. Download preview PDF.
- Abel AB (1983) Optimal investment under uncertainty. Am Econ Rev 73: 228–233Google Scholar
- Barradale MJ (2008) Impact of policy uncertainty on renewable energy investment: wind power and PTC, USAEE WP 08-003. University of California, BerkeleyGoogle Scholar
- Green R (2008) Carbon tax or carbon permits: the impact on generators’ risks. Energy J 69(3): 67–89Google Scholar
- Magnusson G (1969) Production under risk. Acta Universitatis Upsaliensis, Studia Oeconomica Upsaliensia, 2. Uppsala University, UppsalaGoogle Scholar
- Pindyck RS (1982) Adjustment costs, uncertainty and the behavior of the firm. Am Econ Rev 72(3): 415–427Google Scholar
- Sandmo A (1971) On the theory of the competitive firm under uncertainty. Am Econ Rev 61: 65–73Google Scholar