CO2 Trading: Design & Behaviour

In an experimental study, we investigate whether the existence of CO2 externalities lead to changes in trading behavior and how regulation responds to the existence of CO2 externalities. Participants in the role of producers have the opportunity to realize revenues by buying a certificate in a market in order to produce, which, however, creates a real-world CO2 externality. Participants in the role of judges have to regulate central market parameters. Our experimental treatments implement economically equivalent auction and price mechanisms and analyze how the presence of CO2 externalities affects market outcomes. We find that in the presence of a CO2 externality, judges are significantly more likely to restrict or prohibit trade, and producers are significantly less likely to buy, thus foregoing non-negligible monetary revenues. This is true for both the auction and the price mechanism. At the same time, the mechanisms lead to substantially different outcomes: The auction mechanism leads to low prices with voluntary reduction of CO 2 emissions and higher producer rents. At the same time, the total reduction of CO2 emissions is larger with the price mechanism. The reason is that voluntary emission reduction makes room for emitters in auction mechanism, but not in the price mechanism.