Intertemporal Permit Trading for Stock Pollutants with Uncertainty∗

This paper explores the efficiency of tradable permit markets for stock pollutants. With uncertainty about the future stock level or damages, a market with banking and borrowing is inferior, in terms of efficiency, compared to a market without banking and borrowing if the regulator commits to an initial allocation of permits. This result occurs because, with banking and borrowing and commitment, the regulator needs to specify the total allowable amount of emission over time at the initial time period before the uncertainty with the pollution stock is resolved. An alternative banking and borrowing scheme is proposed, where the regulator can update the allocation of permits to firms over time and achieve the efficient pollution accumulation. (JEL code: Q25) ∗The author thanks Stephen Polasky for numerous helpful suggestions. Comments from seminar participants at the University of Minnesota are also acknowledged. The author is responsible for any remaining errors. †Department of Applied Economics, University of Minnesota. Email: [email protected]. Copyright 2002 by Nori Tarui. All rights reserved. Readers may make varbatim copies of this document for non-commercial purposes by any means, provided that this copyright notice appears on all such copies.