SELLER INCENTIVE PROPERTIES OF EPAS EMISSION TRADING AUCTION

The new Clean Air Act Amendments instruct the Environmental Protection Agency (EPA) to conduct annual sealed bid/offer auctions of emission allowances. The auction pricing rules are discriminative and sellers with the lowest asking prices receive the highest bids. This paper assesses the seller incentives of this auction and demonstrates that the auction rules cause sellers to choose asking prices that under-reveal their cost of emission control. Furthermore, increasing the number of sellers intensifies this misrepresentation if the number of buyers remains fixed. The EPA’s rules can therefore generate significantly biased price signals and reduce the efficiency of the allowance trading market. © 1993 Academic Press. All rights reserved.