Carbon Pricing and Resale in Emission Trading Systems

TL;DR

This paper examines how secondary markets in emission trading systems can lead to speculation and misallocation, emphasizing the importance of efficient initial permit allocation and exploring alternatives like frequent auctions.

Contribution

It highlights the impact of secondary markets on auction behavior and proposes that improving initial allocation efficiency can mitigate speculation and rent-seeking.

Findings

Secondary markets can increase untruthful bidding in auctions.

Inefficient initial allocation enables rent-seeking by speculators.

Efficient secondary markets still result in potential rent loss.

Abstract

Secondary markets and resale are integral components of all emission trading systems. Despite the justification for these secondary trades, such as unpredictable demand, they may encourage speculation and result in the misallocation of permits. In this paper, our aim is to underscore the importance of efficiency in the initial allocation mechanism and to explore how concerns leading to the establishment of secondary markets, such as uncertain demand, can be addressed through alternative means, such as frequent auctions. We demonstrate that the existence of a secondary market could lead to higher untruthful bids in the auction, further encouraging speculation and the accumulation of rent. Our results suggest that an inefficient initial allocation could enable speculators with no use value for the permits to bid in the auction and subsequently earn rents in secondary markets by trading these permits. Even if the secondary market operates efficiently, the resulting rent, which represents a potential loss of auction revenue, cannot be overlooked.