Firm behavior in pollution permit markets

Policy makers are increasingly relying on emissions trading programs to address environmental problems caused by air pollution. These programs can significantly affect product market outcomes in polluting industries through their effects on firms' production and investment incentives. Conversely, the structure and economic regulation of polluting industries can undermine the efficiency of pollution permit markets. These inter-market interactions raise a series of interesting questions that motivate the three chapters of this dissertation.; The first chapter considers how variation in economic regulations and investment incentives across product markets regulated under a multi-state cap-and-trade (CAT) program can create inefficiencies in the pollution permit market. Using variation in state-level electricity industry restructuring activity, I identify the effect of economic regulation on pollution permit market outcomes. I find that plants in states with restructured electricity markets are less likely to adopt more capital intensive compliance options. This economic regulation effect, together with a failure of the permit market to account for spatial variation in marginal damages from pollution, have resulted in increased health damages. Had permits been defined in terms of units of damages instead of units of emissions, more of the mandated emissions reductions would have occurred in restructured electricity markets, thereby avoiding hundreds of premature deaths per year.; In the second chapter, using panel data from Southern California's RECLAIM program, I find that initial allocations are a statistically significant determinant of firm-level emissions. This relationship between allocation and emissions is stronger among firms with relatively high transaction costs. These findings suggest that care should be exercised in the initial allocation of permits to ensure efficiency.; The third chapter presents a model of an oligopolistic industry in which a subset of producers are subject to CAT regulation. Regional CO2 CAT programs regulate only a subset of firms in wholesale electricity markets. These electricity markets are characterized by imperfect competition and active forward trading. Pollution reductions among regulated firms can be substantially offset by "leakage" of production to unregulated producers. I find that the existence of a forward product market exacerbates leakage problems; these problems can be mitigated by output-based updating of firm-level permit allocations.