While the prevalence of transaction costs in past and existing emissions trading schemes is a well-documented fact, the related theoretical literature has to a large extent ignored this practical issue and its implications for policy outcomes. In this paper the authors address this gap by developing a theoretical model of emissions trading in the presence of transaction costs. They calibrate the model to annual transactions and compliance data in the European Union emissions trading scheme (EU ETS) over its second phase (2008–2012). The analysis shows that accounting for transaction costs when modelling permit markets has equally important implications for evaluating past policy outcomes and assessing the impacts of possible future design of policy.
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