Designing a Market: The Sulfur Dioxide Emissions Market and Policy, 2000-2003
The market for Sulfur Dioxide (SO2) emissions was created in 1995 using bold regulatory tools and operates in a complex system of energy and electric utility markets. The success of this program to reduce pollutants like SO2 led to plans to adopt similar programs for international regulation of greenhouse gases like Carbon Dioxide (CO2). Studying the best practice design of the market for SO2 can help in planning such new markets. This paper show that once the SO2 market was designed and became functional, the regulatory process that put it into motion did not always go uncontested. The contesting of the regulatory regime by policy makers, and even the United States Environmental Protection Agency (EPA), led to periods where the future design of the market was unclear. The aim of this paper is to measure this lack of clarity and its effect on SO2 allowance prices. While this paper attempts to measure this policy effect in the SO2 market, it also recommends that policy makers be aware of this effect so that they plan their policies systematically and with longer term agendas. Testing the effect of policy change on the level and volatility of Sulfur Dioxide allowance prices can better our understanding of the sensitivity of this market to changes in regulation, policy and legislative announcements. The period under study is September 2000 to January 2003. During this period the paper attempts to ask the question: Did policy, regulation and legislation affect price change and price volatility in the market for Sulfur Dioxide? The coding of these policy variables involved a systematic process of reading hundreds of policy announcements and news pages, thus constructing an uncertainty variable which reflected different degrees of uncertainty these announcements generated. The paper attempts to test the hypothesis that regulatory uncertainty increases volatility. The models estimated - both time-trended OLS and Autoregressive Conditional Heteroskedasticity (ARCH) models - found that though most of the change in SO2 prices is due to market forces, like the price of coal and natural gas, uncertainty in the regulatory regime and the 'politics of pollution' are also significant.
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Yoshii, Yasushige. (Georgetown University, 2010)
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Higgins, Trevor. (Georgetown University, 2010)