Auctioning and Grandfathering in Emission Trading under Risk-Aversion and Ambiguity-Aversion

Professor, Taipei University

This paper explores firms’ optimal investments in environmental R&D under the schemes of auctioning and the grandfathering in emission trading system with random permit prices. In the competitive output and permit markets, our results show that risk-averse firms will invest more in whichever scheme having larger average permit prices and the prices' volatilities. If being risk-neutral, firms will always invest more in the auctioning scheme. These outcomes will remain true if firms are ambiguity-averse or if output and permit markets are duopolistic. These findings suggest that the trading scheme with high permit price floors and/or large differences between ceilings and floors of permit prices can promote firms' environmental R&D investments.