Auctioning emission permits in a leader-follower setting

Alvarez, Francisco and André, Francisco J. (2015): Auctioning emission permits in a leader-follower setting.

Abstract

We analise emission permit auctions under leader-follower competition when the leader bids strategically and the follower acts as price-taker both at the auction and the secondary market. We obtain linear equilibrium bidding strategies for both firms and a unique equilibrium of the auction, which is optimal ex-post for the leader. Under specific distributional assumptions we conclude that the auction always awards less permits to the leader than the cost-effective amount. Our central result is a cautionary note on the properties of auctioning under market power. Under interior solution the auction allocation is dominated by grandfathering in terms of aggregated cost with probability one. As a policy implication, the specific design of the auction turns out to be crucial for cost-effectiveness. The chances of the auction to outperform grandfathering require that the former is capable of diluting the market power that is present in the secondary market.

• Item Type: MPRA Paper
• Language: English
• Keywords: Cap-and-trade systems, auctions, grandfathering, market power, Bayesian games of incomplete information.
• Subjects: D - Microeconomics > D4 - Market Structure, Pricing, and Design > D44 - Auctions; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L13 - Oligopoly and Other Imperfect Markets; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q5 - Environmental Economics > Q58 - Government Policy

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