San Francisco Bridge
October 1, 2014

Non-staff authors: Charles Holt, Thaddeus Huetteman

We use a set of economic experiments to test the effects of some novel features of California's new controls on greenhouse gas emissions. The California cap and trade scheme imposes limits on allowance ownership, uses a tiered price containment reserve sale, and settles allowance auctions based on the lowest accepted bid. We examine the effects of these features on market liquidity, efficiency, and price variability. We find that tight holding limits substantially reduce banking, which, in turn reduces market liquidity. This impairs the ability of traders to smooth prices over time, resulting in lower efficiency and higher price variability. The imposition of holding limits in the allowance market may increase the likelihood of the market manipulation that they were intended to prevent.

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