Testing the efficiency of a tradeable permits market

Abstract

A tradeable permits market is said to be efficient when all affected firms trade permits until their marginal costs equal the market price. Detailed firm-level data are generally required to perform such an efficiency test, yet such information is rarely available. If firms face a declining target, however, and are allowed to bank permits, as has occured recently, aggregated data such as the evolution of the permits bank is sufficient to test for either less than optimal market participation or the exercise of market power. An application to the U.S. sulfur dioxide emission permits market is provided.