Transactions Costs in Tradable Permit Markets: An Experimental Study of Pollution Market Designs

Regulators' choices of market rules and permit allocations influence tradable emission permit programs. This paper uses laboratory experiments to study how transaction costs interact with permit allocations to determine the cost-effectiveness of emissions abatement. With positive transaction costs, in theory the initial distribution of permits can affect both abatement costs and equity. Consistent with theory, we find that with declining marginal transaction costs prices deviate less from the efficient level if the "misallocation" of the initial permit distribution is greater, and the deviation from efficient prices does not vary with the initial permit endowment when marginal transaction costs are constant.