Explaining Low Sulfur Dioxide Allowance Prices: The Effect of Expectation Errors and Irreversibility

Juan-Pablo Montero and A. Denny Ellerman

Sep-98

The low price of allowances has been a frequently noted featured of the implementation of the sulfur dioxide emissions market of the U.S. Acid Rain Program. This paper presents theoretical and numerical analyses that explain the gap between expected and observed allowance prices. The main contributing factors appear to be expectation errors augmented by the presence of irreversible investments.