Abstract of the research project
Corina Madalina Haita
Central European University, Budapest
November, 2010
Dissertation Title: An Emissions Trading Scheme with Auction
My research is focused on the effects of the design changes of the European
Union Emissions Trading Scheme (EU ETS) which will take place starting from the third
phase of the scheme, in 2013. In the first paper of my dissertation I build a model which
mimics this scheme, capturing the most important design element to be applied from
2013 – auctioning as the initial allocation method. According to the rules of the scheme,
firms are endowed with permits through a uniform price auction conducted by the
regulator. Subsequently they can trade these permits in the secondary market. Firms
bidding decisions in the auction as well as their decisions to buy, sell or be inactive in the
secondary market are determined by maximizing a constant absolute risk aversion utility
function of profits. Ultimately, their decisions depend on various cost parameters and the
price of their final product.
The model incorporates firms’ sensitivity to the business cycles, as well as the
presence of speculators in the markets for permits. The aim is to depict the main features
of the scheme and to characterize the compliance strategies of risk-averse firms in an
economy governed by uncertainty. Firms are assumed to have idiosyncratic intensities in
their responses to the economy-wide shock. As the secondary market does not involve
any frictions, firms’ output and abatement decisions are efficient – they do not depend on
the initial allocation of permits, i.e. on who earns the permits in the auctioning stage. In
addition, the secondary market price is unaffected by the presence of the speculators in
the permits' markets, but their presence has welfare implications. However, the auction
price does depend on both the number and the cyclicality of the speculators. Moreover, I
find that firm's valuation for permits in the auctioning stage is increasing in the risk
aversion, the variance of the aggregate shock to the whole economy, the total amount of
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permits issued and in the expected price of the output market, if the firm is countercyclical given that on average polluters are pro-cyclical.
Further, I intent to set up a laboratory experiment based on the above model
searching for behavioral implication of the rules of this scheme. More precisely, it is very
likely that a form of “sunk cost fallacy” may manifest under the auctioning regime.
Hence, I am planning to test for firms’ differences in behavior between the two methods
of initial allocation: free allocation versus auctioning. The hypothesis I intend to test is
that firms will be more reluctant to sell the permits in the secondary market when they
bid and pay a real cost for the same amount of permits they would receive for free. If this
hypothesis holds, then the secondary market will be less liquid under the auctioning
regime, which further affects the efficiency of the production decisions. From this point
of view the adoption of the auction as initial allocation method may not be the optimal
decision of the regulator.
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