Cost effective and environmentally safe emission trading under uncertainty

The aim of this paper is to analyze robust cost-effective and environmentally safe carbon emission trading schemes under uncertainties of emissions and costs, and asymmetric information of participants. The proposed model allows to control explicitly the safety of Kyoto (or other) targets by taking long-term perspectives on emission trading. The dynamics of this scheme is driven by bilateral trades with different endogenous disequilibrium prices between mutually beneficial trades, but finally the system converges to cost-effective and environmentally safe global equilibrium. The safety constraints work as a discounting mechanism that discounts the reported emissions to detectable undershooting levels. This, in turn, provides incentives for participants to reduce uncertainties. The model shows that uncertainties and short term market perspectives may easily prevent price-based trading to be environmentally safe and cost-effective scheme. The desirable equilibrium emerges only under proper price-formation mechanisms. The role of the proposed computerized multi-agent trading system is central for dealing with long-term perspectives, irreversibility and lock-in equilibriums of trades. This system can be viewed as a device for decentralized collective regulation of trades based on unified approaches to modeling of uncertainty, calculation of costs and trading rules.

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