Modeling the impact of uncertainty in emissions trading markets with bankable permits

Abstract

The various forms of uncertainty that firms may face in bankable emission permit trading markets will affect firms’ decision making as well as their market performance. This research explores the effect of increased uncertainty over future input costs and output prices on the temporal distribution of emission. In a dynamic programming setting, the permit price is a convex function of stochastic prices of coal and electricity. Increased uncertainty about future market conditions increases the expected permit price and causes a risk neutral firm to reduce ex ante emissions in order to smooth out marginal abatement costs over time. Finally, safety valves, both low-side and high-side, are suggested to reduce the impact of uncertainty in bankable emission trading markets.

Keywords

uncertainty / bankable / emission trading / market performance

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Acknowledgements

This research is supported by the National Natural Science Foundation of China (Grant No. 70903030). We also thank Prof. Zhang Fan for her previous work and helpful suggestions on our research.

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