Incentives for investment in advanced pollution abatement technology in emission permit markets with banking

We examine the incentives that firms have to invest in cleaner abatement technology when the banking of permits is allowed in emission permit trading schemes. We show that under certainty permit banking can distort incentives for investment and lead to a sub-optimal amount of investment spending. Under imperfect information, aggregate abatement cost uncertainty and investment irreversibility provide arguments for allowing banking. We generalize the model to consider these, showing that some banking is desirable but that it need not be the case that the private banking solution is optimal.