A Model of Intertemporal Emission Trading, Banking, and Borrowing

This paper provides a general treatment of emission trading, banking, and borrowing in an intertemporal, continuous-time model. Using optimal-control theory, the decentralized behavior of firms is shown to lead to the least-cost solution attainable under joint-cost minimization. Explicit solutions for the time paths of emissions and permit prices are derived when firms are allowed to both bank and borrow and when firms are only allowed to bank emission permits. The policy implications of emission banking and borrowing are discussed.