On the Costs of Reducing GHG Emissions and its Underlying Uncertainties in the Context of Carbon Trading

This paper considers the problem of trading uncertain emissions under the Kyoto Protocol. We analyze a market structure that encourages the reduction of inventory uncertainty, although this option is not explicitly mentioned in the Protocol. According to the setting, parties to the Protocol are allowed to meet their targets by reducing emissions, buying permits, or reducing relative uncertainty. The goal of the paper is to account for the dependence in reductions of both emissions and uncertainty. Although formally a carbon emissions market may be restrained from the convergence to its least cost solution, a numerical experiment shows that it reaches equilibrium on its own. The necessary conditions for cost-effective solutions have been derived for the case of cost functions modeled with quadratic functions