Emission Trading System: prices, reduction, and trade

The Emissions Trading System (ETS) is considered as one of the most cost-effective way to reduce polluting emissions. In this paper, we propose a mechanism design for the ETS and provide analytical characterization of equilibrium prices for polluting allowances that are determined by firms’ optimal trade and emissions reduction. We uncover achievements in meaningful reduction only through the aggregate effort of going low-carbon. To validate the analysis, we are able to replicate the European ETS showing the relevance of our results.