Regulated and non-regulated companies, technology adoption in experimental markets for emission permits, and option contracts

Abstract

This paper examines the investment strategies of regulated companies in abatement technologies, market participants' trading behaviors, and the liquidity level in an inter-temporal cap{and{trade market using laboratory experiments. The experimental analysis is performed under varying market structures: the exclusive presence of regulated companies; the inclusion of subjects not liable for compliance with environmental regulations; the availability of plain vanilla options. In line with theoretical models on irreversible abatement investment, the first experiment shows that regulated companies trade permits at a premium. At the same time the existence of a strict enforcement structure effectively prompts investments in new technologies.The second experiment shows that the presence of non-regulated companies adds liquidity to the market and does not increase price volatility. The last experiment enablesus to investigate the impact of the presence of cash-settled options contracts on the trading strategies of regulated companies. Their expected emissions appears to play a significant rolein the choice of their options strategy.