Permit market auctions with allowance reserves

Abstract

This article investigates pollution permit auctions that incorporate allowance reserves. In these auctions the sale of a fixed quantity of permits is supplemented by an additional permit reserve. This reserve automatically releases permits if a sufficiently high price is triggered. The main justifications for implementing an allowance reserve are to reduce price volatility as well as assisting in cost containment. We show-paradoxically-that incorporating an allowance reserve into a permit auction can decrease firms' payoffs, increase the clearing price, and increase compliance costs. This has implications for all major cap-and-trade markets, including the US Regional Greenhouse Gas Initiative.

A review of multiunit auctions with homogeneous goods

“…Supply can be determined endogenously when the seller strategically chooses the quantity offered to increase revenue. The seller may choose the supply after observing the bids (Back & Zender, 2001) or pre‐commit to a known supply curve prior to bidding (Khezr & MacKenzie, 2018b; LiCalzia & Pavan, 2005). In either case, the seller's behavior is taken into account by the bidders when constructing their bidding strategies.…”

“…Further evidence on other markets that utilize multiunit auctions is essential to improve our understanding of these auctions' performance. For instance, a common practice in markets for emissions is to use different formats of the uniform‐price auction to sell emission permits (Khezr & MacKenzie, 2018b). Empirical evidence regarding these markets' performance would provide a better understanding of bidding behavior and equilibria of the uniform‐price auction.…”

Multi-Unit Auctions: A Survey of Theoretical Literature

“…Supply can be determined endogenous when the seller strategically chooses quantity offered to increase revenue. The seller may choose the supply after observing the bids (Back and Zender 2001) or pre-commit to a known supply curve prior to bidding (Khezr and MacKenzie, 2018b;LiCalzia and Pavan, 2005). In either case, the seller's behaviour is taken into account by the bidders when constructing their bidding strategies.…”

“…McAdams (2007) suggests in this case both the expected revenue and the social welfare could be higher than a case where the auctioneer pre-commits to a fixed quantity of units. Khezr and MacKenzie (2018b) model the supply using a step function where either a low quantity or a high quantity is offered. There is a reserve price, below which no units sell.…”

“…By using a step function the seller can gain greater revenues and firms may have lower payoffs. Khezr and MacKenzie (2018a) study a special supply regime motivated by the California's market for emissions, where all players are endowed by fractions of total units and must consign these units into the auction. They show there exist e class of equilibria where firms are essentially indifferent between equilibrium prices since they will receive their own endowed units.…”