Elizabeth M. Bailey, March 1998
The Clean Air Act Amendments of 1990 initiated the first large-scale use of the tradable permit approach to pollution control. The theoretical case for this approach rests on the assumption of an efficient market for emission rights. This paper presents the inter-temporal pattern of allowance prices that should be observed in the market for sulfur dioxide allowances in world of certainty with no transaction costs, and demonstrates that this pattern is roughly consistent with what is observed. Where there are deviations, these deviations can be explained using the theory that is applied to other well established, well functioning markets. The empirical analysis in this paper suggests that the forward market for emission rights has become reasonably efficient.