On the Initial Allocation of Tradeable Pollution Permits

The objective of this thesis is to investigate the initial allocation of pollution permits in a dynamic tradeable market. Tradeable pollution permit markets are an increasingly common method of environmental regulation and it is apparent that future schemes may have a number of repeated compliance periods. It is important to consider how and to what extent the dynamic allocation of pollution permits determines the market e¢ ciency at the equilibrium. This objective is developed in three parts. First, Part I introduces the topic and sets out the current relationships that exist between the initial allocation of permits and market e¢ ciency and …nds strong links between the two. It is shown that markets with imperfect competition, transaction costs or multiple periods can result in links between the initial allocation and market e¢ ciency. In Part II, a generalised model is created to investigate the optimality of dynamic permit allocations and …nds the dynamic use of grandfathering (free allocation based on emissions information) permits is, in general, sub-optimal. It is argued that alternative dynamic mechanisms should be considered, such as auctions and other relative performance mechanisms. Part II is concluded by an investigation into the link between market e¢ ciency, dynamic initial allocations and …rms’lobbying over a permit allocation. Firms have the ability to determine their permit allocation by their choice of emissions and lobbying activity. It is shown that in some circumstances, lobbying activity may alter market e¢ ciency and may result in reductions in social welfare. In Part III, an alternative dynamic allocation mechanism is considered, namely a rank-ordered contest, which can optimally allocate permits and simultaneously accomplish a predetermined secondary policy objective.