Attitudes toward risk and compliance in emission permit markets

We investigate the effects of uncertainty and concomitant risk aversion as they impact the incentive structure and subsequent operation of an emissions permit marker modeled after the U.S. SO2 marker. Our theoretical results suggest that uncertainty dulls incentives to achieve cost savings through permit trading and inhibits efficient allocation of abatement efforts by firms. We test hypotheses in an experimental laboratory setting and find that the irreversibility of investment in abatement technology may present countervailing incentives for potential sellers of permits, resulting in a wait and see attitude toward adoption of efficient levels of abatement technology.