A0404
Title: Rules vs. discretion in cap-and-trade programs: Evidence from the EU emission trading system
Authors: Marina Friedrich - VU Amsterdam (Netherlands) [presenting]
Sebastien Fries - VU Amsterdam (Netherlands)
Michael Pahle - PIK Potsdam (Germany)
Ottmar Edenhofer - PIK Potsdam (Germany)
Abstract: Long-term commitment is crucial for the dynamic efficiency of intertemporal cap-and-trade programs. Discretionary interventions in such programs could destabilize the market and necessitate subsequent corrective interventions that instigate regulatory instability. We provide evidence for this claim from the EU's cap-and-trade program (EU-ETS). We ground our analysis in the theoretical finance literature and apply a mixed-method approach (time-varying coefficient regression, bubble detection, crash-odds modelling). We find that the recent EU-ETS reform triggered market participants into speculation, which likely led to an overreaction that destabilized the market. We discuss how the smokescreen politics behind the reform, which manifested itself in complex rules, was crucial for this outcome. We conclude that rules only ensure long-term commitment when their impact on prices is predictable.
