There is significant interest in the use of market mechanisms for controlling nutrient pollution, one of the most challenging threats to water quality in the United States and elsewhere. This type of pollution often is characterized by considerable lag times between discharge from the pollution source and delivery to the impaired waters. We investigate the implications of these lags for efficient pollution reduction markets and compare two alternative market designs: 1) forward markets where participants trade pollution deliveries directly and 2) a trading ratio system where they trade contemporaneous discharges. While a system of first-best trade ratios is complex in early periods, this system can produce the optimal steady state loads using a simple trading rule. We also find that while first-best trade ratios are greater than one when there are lag disparities between trading partners, second-best trade ratios under the same lag disparities may be less than one when the overall cap on discharges is set sufficiently small.


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