Emissions variability in tradable permit markets with. imperfect enforcement and banking

In this laboratory experiment on emissions trading, subjects face exogenous, random emissions shocks after making production and emission control plans. In some sessions subjects can bank their unused permits for future use. After a reconciliation-trading period following the shock realization, subjects report their emissions to the regulatory authority and are placed in different inspection groups depending on their compliance history. We identify important interactions between banking, compliance and enforcement. Banking smoothes out the price variability arising from imperfect emissions control. Price stability comes at a cost, however, since noncompliance and emissions are significantly greater when banking is allowed. (c) 2006 Elsevier B.V. All rights reserved.