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Marketable Pollution Permits with Uncertainty and Transaction Costs

Increasing interest in the use of marketable permits for pollution control has become evident in recent years. Concern regarding their performance still remains because empirical evidence has shown transaction costs and uncertainty to be significant in past and existing marketable permits programs. In this paper we develop theoretical and numerical models that include transaction costs and uncertainty (in trade approval) to show their effects on market performance (i.e., equilibrium price of permits and trading volume) and aggregate control costs. We also show that in the presence of transaction costs and uncertainty the initial allocation of permits may not be neutral in terms of efficiency. Furthermore, using a numerical model for a hypothetical NOx trading program in which participants have discrete control technology choices, we find that aggregate control costs and the equilibrium price of permits are sensitive to the initial allocation of permits, even for constant marginal transaction costs and certainty.