Reconsidering Carbon Permits Auction Mechanism: An Efficient Dynamic Model

Abstract One of major concerns for China and developing countries is the new international trade rule concerning carbon emissions, which one needs to know its suitable mechanism and the possible implication on China's carbon trading market. Precisely, in an emission‐and‐trade scheme, an important question is whether the auction outcome is efficient, since this is closely related with the economic costs of emissions reduction. Due to the unique features of carbon permits, existing auction mechanisms do not seem to be suitable for their distribution. Inspired by the tâtonnement process, this paper proposes a new auction mechanism for them. For both practical application and theoretical extension, the discrete and continuous situations are examined, respectively. The result shows that the proposed auction converges to Pareto optimal equilibria, and that without ties, the equilibrium is unique. For bidders, the straightforward bidding strategy is the most preferred one, in the sense that the strategy makes them avoid the risk of loss. Intuitively, the auctioneer's utility is increasing in the number of bidders, while bidders’ pay‐off is increasing in permits. To a certain extent, the proposed auction mechanism resolves the confliction between efficiency and revenue in the multi‐item auction theory, while it increases people's understanding for carbon emission auction mechanism design.