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Published April 2010 | Published
Journal Article Open

An experimental study of auctions versus grandfathering to assign pollution permits


We experimentally study auctions versus grandfathering in the initial assignment of pollution permits that can be traded in a secondary spot market. Low and high emitters compete for permits in the auction, whereas permits are assigned for free under grandfathering. In theory, trading in the spot market should erase inefficiencies due to initial mis-allocations. In the experiment, high emitters exercise market power in the spot market, and permit holdings under grandfathering remain skewed towards high emitters. Furthermore, the opportunity costs of "free" permits are fully "passed through." In the auction, the majority of permits arewon by low emitters, reducing the need for spot-market trading. Auctions generate higher consumer surplus and slightly lower product prices in the laboratory markets. Moreover, auctions eliminate the large "windfall profits" that are observed in the treatment with free, grandfathered permit allocations.

Additional Information

© 2010 by the European Economic Association. The editor in charge of this paper was Stefano DelaVigna. We gratefully acknowledge financial support from the Dutch National Science Foundation (VICI 453.03.606), the Bankard Fund for Political Economy, Mistra's Climate Policy Research Forum (Clipore) and the US Environmental Protection Agency. We would like to thank Helen Bernhard, Noemi Nagi, Thomas Neumeyer, Nina Spiri, and Sean Sullivan for their help with the experiments, and participants at the European Economic Association Meetings (Barcelona, August 2009) for useful comments.

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