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Abstract

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.

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