Thin versus thick CO2 market

The idea that trading is more costly the thinner the market is is common in most studies of market exchange with frictions. Surprisingly, this element is lacking from previous attempts to allow for frictions in pollution perm it markets. This paper considers a CO2 cap-and-trade model where trading co sts develop endogenously as a function of the market size. The pre-trade al location of permits determines whether the market size can be strongly infl uenced by expectations that have a role because of adjustment costs. The pr e-trade allocation also sets preconditions for endogenously vanishing tradi ng costs and thus has nonstandard effects on long-run trading levels and ma rket allocations, (C) 2000 Academic Press.