International carbon trade with constrained allowance choices

<p>International carbon markets are advocated in order to involve more countries in an agreement for the mitigation of greenhouse gas emissions and to reduce the costs of mitigation. In this paper we develop a model where allowances are endogenously determined by each member of a carbon trade agreement, but with an exogenous constraint on the number of allowances per member. We use a global model to explore the incentives for regions to participate in such a carbon market and we examine its performance. To gain practical policy insights, we employ the STACO model, a numerically calibrated model with twelve world regions. Our results show that the stability and effectiveness of an international carbon market can be improved by imposing constraints on individual allowance choices compared to a carbon market without such constraints. Constraints on allowance choices reduce ‘hot air’ and increase global welfare and mitigation. When tightening the constraint ‘broad but shallow’ agreements are replaced by ‘narrow but deep’ ones. If the constraint is too tight, however, no stable carbon market exists.