December 13, 2010

Cap-and-Trade Properties under Different Hybrid Scheme Designs

by Georg Grüll and Luca Taschini

- This paper examines the key design mechanisms of existing and proposed cap-and-trade markets. First, it is shown that the hybrid systems under investigation (price floor using a minimum price guarantee, price collar, allowance reserve, options offered by the regulator, and offset relaxation) can be decomposed into a combination of an ordinary cap-and-trade scheme with European- or American-style call and put options. Then, we quantify and discuss the advantages and disadvantages of the proposed hybrid schemes by investigating whether pre-set objectives can be accomplished while maintaining the original environmental targets. Plain vanilla options are proposed as an alternative that reconciles the otherwise conflicting policy objectives.

Grüll, G. and L. Taschini (2010). "Cap-and-Trade Properties under Different Hybrid Scheme Designs." Grantham Research Institute on Climate Change and the Environment Working Paper No. 26, Sept 2010.