Temporal flexibility of permit trading when pollutants are correlated

It is now accepted that climate change is due to the cumulative and joint effect of multiple atmospheric trace constituents. The importance of adopting a comprehensive approach to global warming that would account for multiple interacting pollutants is increasingly recognized. In this paper we propose to extend the analysis of intertemporal permit trading to a framework encompassing multiple correlated pollutants. In doing so our aim is to assess the consequence of providing "when flexibility" to participants in a pollution market scheme with respect to the timing of use of their permits. In the same manner as local pollution hotspots have been identified as potential drawbacks of allowing intra-regional trade, temporal flexibility has the potential to induce a type of "temporal hotspot" of pollution that could undermine the efficiency of intertemporal trading schemes especially when the stock of a particular pollution induces damage in itself but also impacts on the accumulation of another detrimental pollution stock. In a first step, we assess the impact of various types of correlations (technological and physical) on the socially optimal accumulation of regional and global pollutants. We illustrate that even in the case of a linear damage function the regional stocks may have ambiguous impacts on the global stock. In a second step, we show that it is possible for a global benevolent regulator to have recourse to a set of intertemporal trading schemes to induce individual agents to take socially optimal decisions over time. One requirement is to implement a set of time-dependent intertemporal trading rates. We also analyze the impact on pollutants accumulation of implementing non-optimal intertemporal trading rates. (C) 2011 Elsevier Ltd. All rights reserved.