Pollution permits, strategic trading and dynamic technology adoption

Produced as part of the Governments, markets and climate change mitigation CCCEP research programme theme

Working Paper 45


This paper analyses the dynamic incentives for technology adoption under a transferable permits system, which allows for strategic trading on the permit market.

Initially, firms can invest both in low-emitting production technologies and trade permits. In the model, technology adoption and allowance price are generated endogenously and are interdependent. It is shown that the non-cooperative permit trading game possesses a pure-strategy Nash equilibrium, where the allowance value reflects the level of uncovered pollution (demand), the level of unused allowances (supply), and the technological status.

These conditions are also satisfied when a price support instrument, which is contingent on the adoption of the new technology, is introduced. Numerical investigation confirms that this policy generates a floating price floor for the allowances, and it restores the dynamic incentives to invest.

Given that this policy comes at a cost, a criterion for the selection of a self-financing policy (based on convex risk measures) is proposed and implemented.

Santiago Moreno-Bromberg and Luca Taschini