Discussion Paper No. 492

DESIGNING GHG EMISSIONSTRADING INSTITUTIONSIN THE KYOTO PROTOCOL:
AN EXPERIMENTAL APPROACH

Yoichi Hizen
andTatsuyoshi Saijo

January 2000

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan

Designing GHG Emissions Trading Institutions in the Kyoto Protocol:
An Experimental Approach#

Yoichi Hizen1, 2
andTatsuyoshi Saijo3, 4December 1998

# This research was partially supported by CREST (Core Research for Evolutional Science andTechnology) of the Japan Science and Technology Corporation (JST) and Grant in Aid for Research
1278, 08453001 and 0873003 of the Ministry of Education, Science and Culture in Japan. We also
thank Professors Peter Bohm, James C. Cox, Timothy N. Cason, R. Mark Isaac, Michael McAleer,Charles R. Plott and participants of the CREST workshop for helpful comments and discussions, andDr. Yasuko Kawashima of the National Institute for Environmental Studies in Japan for providing
marginal abatement cost information.
1 Graduate School of Economics, Osaka University, Toyonaka, Osaka 560-0043, Japan
2 Research Fellow of the Japan Society for the Promotion of Science.
3 Institute of Social and Economic Research, Osaka University, Ibaraki, Osaka 567-0047, Japan
4 CREST, Japan Science and Technology Corporation, 3-12-40 Hiroo, Shibuya, Tokyo 150-0012, Japan.

ABSTRACTWe re-evaluate two experiments by Hizen and Saijo (1999a,b) to examine theperformance of bilateral trading and double auction institutions in GHG emissions
trading. It is found that: (i) the efficiency of both institutions is quite high, regardlessof the disclosure or closure of contracted price and/or marginal abatement cost curve
information; (ii) marginal abatement costs are equalized over time in both institutions;(iii) contracted prices roughly converge to the competitive price over time in a double
auction, but not quite so in bilateral trading.
Journal of Economic Literature Classification Numbers: C92, Q31, Q38
Correspondence:
Tatsuyoshi Saijo
Institute of Social and Economic Research
Osaka University
Ibaraki, Osaka 567-0047
Japan
Phone 01181-6 (country & area codes)
6879-8582 (office)/6878-2766 (fax)E-mail: saijo@iser.osaka-u.ac.jp

1. Introduction
The Kyoto Protocol to the Climate Convention in December 1997 calls for Annex B
countries (that is, advanced countries and some countries that are in transition to market
economies) to reduce their average greenhouse gas (GHG) emissions over 2008-2012 toabout five percent below 1990 levels. In order to implement this goal, it authorizes threemajor mechanisms called the Kyoto mechanism. These are emissions trading, joint
implementation and the Clean Development Mechanism. However, we must design thedetails of these mechanisms as almost no details are given in the Protocol. The
Conference of Parties at Buenos Aires in November 1998 following the Kyoto Conference
adopted a "Plan of Action," but this plan is a timetable regarding what should be argued
when, and hence no details of the protocol are given. The focus of this paper is to design
desirable institutions for GHG emissions trading through the use of experimental
economics.
Several candidates for emissions trading institutions have been proposed, such as
auctions, bilateral trading, and a mixture of these two. However, no scientific bases havebeen given to support them. For example, as a supplemental institution to auctions, somecountries have proposed bilateral trading. A typical response to this proposal byeconomists, among others, is twofold: (i) it would be inefficient in the sense that somedissatisfied traders could not be eliminated due to mismatching; and (ii) the revelation ofcontracted prices would improve its efficiency. These views are not based upon either
economic theory or empirical evidence.1 As a matter of fact, economic theory often
assumes that the market is a black box, and does not look into the details of trading
institutions. Moreover, actual data on real economic activities cannot inform us how
1 Feldman (1973) showed that allocations through bilateral trading can attain Pareto efficiency in a finite

number of steps.

1efficient the trading institution is. For example, most of the trades in sulfur dioxide
allowance trading in the U.S.A. have been carried out through bilateral trading. Somehave been undertaken through an annual auction designed by the Environmental
Protection Agency (EPA), but it is hard to tell how efficient it is since no comparisons havebeen made with other institutions.2
What would be the best way to evaluate several alternative institutions without
having data and with only limited experience? A new method of understanding theperformance of alternatives has emerged in economics, namely, experimental economics.
For example, the EPA designed a new auction method for sulfur dioxide allowance
trading, hoping to realize relatively high allowance prices. However, the actual prices
around the beginning of trading were significantly lower than those expected by
specialists. Cason (1995) and Cason and Plott (1996) established laboratory experiments
where the trading institution was exactly the same as the EPA auction. Participants(called subjects) in the experiments were motivated by monetary rewards. That is,
subjects who performed well in the laboratory EPA auction received greater
compensation than those who did not perform well. What they found was striking. The
experimental price data were well below the market price, which is exactly the opposite of
the EPA's expectation!
In survey articles, Muller and Mestelman (1998) and Godby, Mestelman andMuller (1988) provide many new findings on emissions trading experiments. Amongothers, experimental economists have found that: (i) allowing banking permits over timesmoothes contracted prices across time periods, and (ii) a trader who has some market
power other than in the emissions trading market can influence the emissions trading
2 Some evaluation of sulfur dioxide emissions trading has just started. See, for example, Schmalensee etal. (1998), Stavins (1998), and Joskow et al. (1998).

2

market, and hence the introduction of the emissions market reduces the efficiency of thewhole economy.
In this paper, we re-examine two papers by Hizen and Saijo (1999a,b) who focusedon bilateral trading and double auction institutions with a special feature called the dualrole property. In most previous experiments in emissions trading, each subject is assigned
to be a buyer or a seller, but not both. That is, once a subject is a buyer, she cannot sell her
allowances even when the price is extremely high. In these experiments, every subject canbe a buyer and a seller depending on the prices, so that a subject can play dual roles inemissions trading. The initiator of this dual role property in emissions trading is Bohm
(1997). He reported bilateral trading experiments among four teams consisting ofexperienced public officials or experts appointed by the Energy Ministries. Each teamrepresented one of the four Nordic countries, and has some information on the marginal
abatement cost curves of all teams. The asks and bids were exchanged by fax without
revealing this information to other teams. It took four days to complete this experiment.
The resulting prices were very close to the competitive equilibrium price and theefficiency of the allocation was 97%, which is surprisingly high.
Following Bohm's important experiment, Hizen and Saijo (1999a) designed abilateral trading experiment with two controls: (i) disclosure or closure of contracted
prices, and (ii) disclosure or closure of marginal abatement cost curves. Thus, there are
four different treatments. In this way, we can understand which case would be the mostappropriate or efficient way to reduce GHG emissions. Furthermore, Hizen and Saijo(1999b) conducted a double auction experiment with the same setting as the bilateral
trading experiment and then compared two institutions. In the double auction, bothbuyers and sellers can actively post and accept prices in a public manner. In Hizen and3

Saijo (1999b), the control was the disclosure or closure of marginal abatement cost curves
since the contracted price information was revealed to all subjects in the double auction.
The first finding is that the efficiency of both institutions is very high, regardless of
information closure or disclosure. That is, disclosure of contracted prices and/or marginal
abatement cost information does not improve efficiency. Allocation efficiency was morethan 99% in 6 sessions, and 98% and 92% in the remaining sessions of the bilateral trading
experiment, and it was more than 99% in all five sessions in the double auction
experiment. This finding contrasts strikingly with the widely accepted view on bilateral
trading. Second, marginal abatement costs are equalized in almost all sessions in both
institutions. Third, while the contracted prices did not converge to the competitive
equilibrium price in the bilateral trading experiment, they roughly converged to the pricein the double auction experiment. This observation is different from Bohm's. Fourth,subjects who could exercise market power did not use that power in the bilateral trading
experiment, but subjects who had market power in the double auction experiment earned
greater profits than they could have earned at the competitive equilibrium price. In eachsession, we had six subjects who were supposed to represent Russia, Ukraine, U.S.A.,
Poland, EU, and Japan. In our setting, only the U.S.A. had market power, and the subjects
who were assigned this role could reduce their quantity demanded in order to lower the
price.
The paper is organized as follows. Section 2 investigates bilateral trading andsection 3 examine a double auction. In section 4, we discuss why efficiency is so high,consider the implication of disclosure of contracted prices, and compare the two
institutions. Section 5 discusses the future agenda.

4

2. Bilateral Trading
2.1 Experimental Design
The bilateral trading experiment has two controls: (i) disclosure or closure ofcontracted prices, and (ii) disclosure or closure of marginal abatement cost curves.
Therefore, there are four treatments. Repeating the same treatment twice yields eight
sessions. In what follows, "O" represents "disclosure" and "X" represents "closure". For
example, "OX2" indicates session 2 in the price disclosure, marginal cost curve closure
treatment.
We recruited at least six students for each session by campus-wide advertisementat Osaka University during October 1998. These students were told that there would be
an opportunity to earn money in a research experiment. None of them had priorexperience in a bilateral trading experiment. It took approximately 160 minutes for eachsession. The mean payoff per subject was $31.25 ($1=115 yen). The maximum payoff was$66.09, and the minimum payoff was $17.39.
---------------------------------Figure 1 is around here---------------------------------Let us describe an "OO" session. Subjects were seated at desks in a relatively large
room and listened to a tape-recorded voice giving instructions. In this part, each subject
received a sample graph (see Figure 1). The upper half is a sample marginal abatement
cost curve. Each subject was told that the initial position is at 0.3 If the subject moves tothe right, she buys the allowance and earns benefits, and if she moves to the left, she sells
the allowance and obtains a profit. All possible situations were depicted in the lower half

3 We implicitly presume that position 0 is the position where each country attains the goal required by

the Kyoto Protocol. In other words, the experimental setting asks what kind of trading should be done inorder to achieve that goal. That is, we did not address the non-compliance issue.
5

of Figure 1. After receiving instructions on how to transact with other subjects, allsubjects took an examination to check their understanding of the instructions. The best six
subjects continued the experiment, and the rest were asked to leave the room with $13.
Then each subject was assigned an identification number from 1 to 6 and, at the same time,each subject received her own marginal abatement cost curve. In the "OO" session, eachsubject received Figure 2 with all six abatement cost curves, and had fifteen minutes to
examine it.4 Then bilateral trading started. Since every subject had a tag with an
identification number, subjects could identify other subjects' marginal abatement cost
curves. Each subject could move around the room freely to find a subject with whom totransact. During negotiations, subjects were not allowed to talk. Only numbers (price andquantity), and "yes" and "no" symbols on their negotiation sheets, were exchanged inorder to avoid information leakage. Once a pair reached agreement, they reported theprice and quantity to an experimenter, who announced these numbers on a blackboard(i.e., contracted price disclosure). The maximum time for negotiations was 60 minutes,
and subjects could end their negotiations early if all subjects agreed to it. The full 60
minutes was used in all sessions except "XO2."---------------------------------Figure 2 is around here---------------------------------During the experiment, we did not use any country names or the term "emissions
trading." That is, subjects faced a situation where trading of an abstract commodity was
conducted with an abstract price.
2.2 Experimental Results
Economists care about the market (or competitive) equilibrium price where thedemand and supply curves intersect since the sum of benefit and profit of all subjects is
4 Since information on the marginal abatement cost curves around 2010 is hard to obtain, we draw these6maximized at this price. Keeping this in mind, we define the efficiency of bilateral trading
as follows:
Sum of benefit and profit of each subject
Sum of benefit and profit at market equilibrium
That is, the maximum efficiency should be one. In our design, the competitive
equilibrium price ranges from 118 to 120 so we regard 119, which is the midpoint between
118 and 120, as the competitive equilibrium price. At this price, the total amount ofbenefit and profit (that is, the maximum amount that these six subjects can enjoy) is 6990.
In Table 1, the top row indicates the name of the sessions, the left column shows the I.D.
numbers of subjects, and the numbers in parentheses are their benefits or profits at thecompetitive equilibrium price. In each cell, the upper figure is the actual benefit or profit
that the subject earned, and the lower figure is the efficiency of this subject. For example,
the 0.732 figure for subject 1 in the "OO2" session is the ratio between 1870 and 2555,
which we call individual efficiency.
OO1
Subject No.

1(2555)(Russia)2(1290)(Ukraine)3(610)(U.S.A.)
4(390)(Poland)5(620)(EU)
6(1525)(Japan)Sum(6990)

OO2

OX1

OX2

XO1

XO2

XX1

XX2

1420
1870
960
1710
1510
0.556 0.732 0.376 0.669
0.591
1140
914
360
1665
1320
0.884 0.709 0.279 1.291
1.023
685
683
2060
372
1846
1.123 1.120 3.377 0.610
3.026
520
570
850
530
500
1.333 1.462 2.179 1.359
1.282
800
1105
1300
755
-150
1.290 1.782 2.097 1.218 -0.242
2425
1800
1450
1844
1400
1.590 1.180 0.951 1.209
0.918
6990
6942
6980
6876
6426
1 0.993 0.999 0.984
0.919

1100
0.431
940
0.729
615
1.008
555
1.423
1080
1.742
2700
1.770
6990
1

1460
0.571
1536
1.191
583
0.956
910
2.333
81
0.131
2390
1.567
6960
0.996

1600
0.626
2370
1.837
550
0.902
500
1.282
150
0.242
1800
1.180
6970
0.997

Table 1. Efficiency of Bilateral Trading

curves based upon some information provided by Dr. Kawashima.
7

As Table 1 shows, the efficiency of each session is quite high, except for "XO1."
The reason for the low efficiency level in this session is that subject 5 traded with othersubjects even though she suffered a loss. Individual efficiencies are quite different evenfor the same subject number. Statistical tests show that Russia consistently earned a much
lower profit than that of the competitive equilibrium and Poland earned a greater profit
than that of the competitive equilibrium. The efficiency of the other countries is close toone. As we discuss later, the only country that had some market power was the U.S.A.
---------------------------------Figure 3 is around here---------------------------------Figure 3 shows efficiency changes over time. After sixteen minutes, the efficiencyof allocation in all sessions except for session "XX2," was greater than 80%, and it wasmore than 90% in 6 sessions of 8 after 25 minutes. Efficiency usually is monotonicallyincreasing, but in session "OX2" efficiency moved up and down. This was due to the factthat one subject bought allowances at a loss, but sold it at a relatively high price.
Summarizing these findings, we have:

Observation 1. (i) The efficiency of bilateral trading is almost one, regardless of closure ordisclosure of price and marginal abatement cost information.
(ii) Russia's efficiency is low, Poland's efficiency is high, and the efficiency of the other countries isclose to one.
(iii) The efficiency of allocation in 6 sessions of 8 was more than 90% after 25 minutes.

Figures 4-1 and 4-2 show contracted prices and quantities, together with asks andbids, over time. The gray horizontal line in each small graph shows the competitive
equilibrium price range of 118-120. The left-hand side number of a square is the seller's
8subject number, the right-hand side number is the buyer's subject number, and thenumber under the square is the contracted quantity. If the variance of the last threecontracted prices is significantly smaller than the variance of the first three prices, then we
say that the contracted price sequence converges. We find convergence of contracted
prices in five of eight sessions, but no information disclosure effect is observed.
-----------------------------------------------------------------Figures 4-1 and 4-2 are around here-----------------------------------------------------------------Observation 2. (i) Contracted average prices in session "XX" (closure of prices and closure of
marginal abatement cost curves) roughly equal the competitive equilibrium price, but the variancesof prices in sessions XX1 and XX2 are larger than those of the rest.
(ii) Average prices cannot be said to equal the competitive equilibrium price in sessions other thanthe "XX" sessions.
(iii) The average price of the last three contracts is not equal to the competitive equilibrium price inevery session.
(iv) The convergence of contracted prices is found in five of eight sessions, but no information
disclosure effect on convergence is observed.

By the nature of bilateral trading, the price contracted by a pair of subjects is determinedby negotiation. Even though several other contracted prices have already beenannounced, a pair of subjects cannot reach an agreement if either of them rejects theseprices. For this reason, the competitive equilibrium price cannot play the role of thestandard of trade.
The effect of disclosure of contracted prices can be calculated by comparing the"OO" and "XO" sessions, and the "OX" and "XX" sessions. Since the variances of9contracted prices in sessions "OX1" and "OX2" cannot be said to be the same, we omitted
these sessions from the comparison. Under this constraint, we compare the "OO" sessions
with the "XO" sessions. No differences are observed among the variances of these sessions.
For the same reason mentioned in the above paragraph, we compare the "XO"
sessions with the "XX" sessions to measure the effect of disclosure of marginal abatement
cost curve information. We find that the variance of contracted prices in the "XO" sessions
is smaller than in the "XX" sessions. Summarizing these facts, we have:

Observation 3. (i) Assuming that each subject knows other subjects' marginal abatement cost
curves well, the disclosure of contracted prices does not have any impact on the variance ofcontracted prices.
(ii) Under the closure of contracted prices, the disclosure of marginal abatement cost curves
reduces the variance of contracted prices.

Behind efficiency, we can see how marginal abatement costs changed over time.
Due to the step-function nature of our marginal abatement cost curve, we must be carefulwhen evaluating marginal costs. For example, the marginal abatement cost of Russia insession "OO1" was 90 after 25 minutes. Checking the raw data, we find that Russia soldexactly 55 units of emissions allowance in 25 minutes. Therefore, if the subject wanted tosell one more unit, its marginal abatement cost would have been 120 (see Figure 2).
Taking account of this fact, we have:

Observation 4. Except for the EU subject in session "XO1," the marginal abatement costs of all
subjects approach the competitive equilibrium price, but the contracted prices do not.

10In order to understand how much market power a country has, we need anaggregate excess demand curve of all subjects regarding marginal abatement cost curves
as the excess demand curves for emissions allowances. After careful examination, we findthat the only country that has market power in our design is the U.S.A. Table 1 showsthat the benefits of the U.S.A. were more than three times the benefit at the competitive
equilibrium in two sessions of eight. A statistical test shows that the U.S.A. did not
exercise market power in any session. Most probably, the subjects could not exploit themarginal abatement cost curve information to use such market power.

3. Double Auction
3.1 Experimental Design
In a double auction, all proposals, including contracted prices and quantities, aredisclosed. Therefore, our double auction experiment has only one control, namely
disclosure or closure of marginal abatement cost curves. We had three disclosure sessions
and two closure sessions, and hence five sessions in total. Following the previous section,
we denote these sessions by "O3", "X2", and so on. The only difference between ourdouble auction and bilateral trading is in the trading method. In the double auction, an
auctioneer calls on a subject who raises her hand the earliest. Then the subject provides
her I.D. number, sell or buy, the quantity and the price per unit. For example, the subject
says, "Subject five sells ten units at one hundred dollars per unit." The auctioneer projects
the proposal on an OHP screen. After the proposal, a subject who raises her hand theearliest can trade with the proposer. The accepted quantity is smaller than or equal to the
proposed quantity. We impose the "improvement rule" on proposals in our double auction,that is, asks (bids) must be successively lower (higher).

11In our double auction experiment, the mean payoff per subject was $28.20, themaximum payoff was $44.70, and the minimum payoff was $17.39. The maximum time
for an auction was 60 minutes, and subjects could end the auction early if all subjects
agreed to it. The full 60 minutes was used in three of five sessions.

3.2 Experimental Results
As Table 2 shows, the efficiency of each session is quite high. Statistical tests showthat Poland consistently earned a lower profit than that of the competitive equilibrium
and the U.S.A. earned a greater profit than that of the competitive equilibrium. The
efficiency of the other countries is close to one.

Subject No.
1 (2555)(Russia)
2 (1290)(Ukraine)
3 (610)(U.S.A.)
4 (390)(Poland)
5 (620)(EU)
6 (1525)(Japan)Sum (6990)

O1

O2

O3

X1

X2

2410
2410
1981
2260
0.943 0.943 0.775 0.885
1320
1320
520
1770
1.023 1.023 0.403 1.372
850
865
1144
681
1.393 1.418 1.875 1.116
200
350
230
209
0.513 0.897 0.590 0.536
750
500
1380
700
1.210 0.806 2.226 1.129
1430
1515
1695
1350
0.938 0.993 1.111 0.885
6960
6960
6950
6970
0.996 0.996 0.994 0.997

2865
1.121
1120
0.868
1270
2.082
355
0.910
0
0.000
1360
0.892
6970
0.997

Table 2. Efficiency of the Double Auction

Figure 5 shows efficiency changes over time. After seventeen minutes, theefficiency of allocation in all sessions except for session "X2," was greater than 70%, andwas more than 90% in all sessions after 44 minutes. Efficiency usually is monotonicallyincreasing, but in sessions "X1" and "X2" efficiency reached 100% once and then fellslightly. For example, in session "X2," one subject sold allowances at a loss, expecting that12

she would buy them at a lower price later but could not. Such a loss was not observed
when the marginal abatement cost information was disclosed.
---------------------------------Figure 5 is around here----------------------------------

Observation 5. (i) The efficiency of the double auction is almost one, regardless of closure ordisclosure of marginal abatement cost information.
(ii) Poland's efficiency is low, the U.S.A.’s efficiency is high, and the efficiency of the othercountries is close to one.
(iii) The efficiency of allocation in all sessions is more than 90% after 44 minutes.
-----------------------------------------------------------------Figure 6 is around here-----------------------------------------------------------------Figure 6 shows contracted prices and quantities, together with asks and bids, overtime. We examine the average price of all contracts and that of the last three contracts tosee where the prices converge. We have:

Observation 6. (i) Regardless of closure or disclosure of marginal abatement cost information,
convergence of prices is observed.
(ii) Average prices of all contracts in sessions "O1", "O2" and "X1" equal the competitive
equilibrium price.
(iii) Average prices of the last three contracts in sessions "O1", "X1" and "X2" equal thecompetitive equilibrium price.

13

We examine the effect of disclosure of marginal abatement cost curves. The
variances of contracted prices in the "O" sessions are smaller than those in the "X" sessions.
In competitive equilibrium, Russia, Ukraine and Poland are sellers while the U.S.A., EU
and Japan are buyers. In the "O" sessions, Russia, Ukraine and Poland only sold theallowances, while the U.S.A., EU and Japan only bought them. The numbers of trade insessions "O1", "O2" and "O3" were 9, 8 and 7, respectively, while those in sessions "X1"and "X2" were 11 and 12, respectively.

Observation 7. The disclosure of marginal abatement cost curves:(i) reduces the variance of contracted prices;(ii) makes Russia, Ukraine and Poland only sell, and the U.S.A., EU and Japan only buy;(iii) reduces the number of trades.

Behind efficiency, we can see how marginal abatement costs changed over time.

Observation 8. Marginal abatement costs of all subjects approach the competitive equilibrium
price.

In our double auction experiment, marginal abatement costs converged less rapidly thanin bilateral trading. We conjecture that this arises because, in the double auction, at mostone pair can trade at the same time while at most three pairs can do so in bilateral trading.

4. Discussions and Comparisons14Extremely high efficiency in Observations 1 and 5 is partly due to the fact that eachcountry can buy and sell the allowance depending on the price, which we call the dual role
property of a trader. We consider that the property is essential in emissions trading.
Consider the following simple demand and supply curves with two suppliers and two
buyers. Each supplier has just one unit of a good. On the other hand, each buyer wants tobuy just one unit of the good. Apparently the competitive equilibrium price must be
between 4 and 7, and the social surplus becomes 8. If buyers can only buy and sellers canonly sell, a mismatch can easily occur. Consider a pair in which the buyer's value is 10
and the seller's cost is 7. If they trade with each other, the surplus is 3. Consider anotherpair in which the buyer's value is 4 and the seller's cost is 2. The surplus of this pair is 2
and hence the sum of the surplus is 5, which is less than 8. After these trades, no mutually
beneficial trade will occur. Now consider the case in which everyone can buy and sell.
After these trades, the buyer whose value is 4 has one unit of the good and hence can sellit. Since the seller whose cost is 7 does not have any good, she can buy it. If this pairtrades with each other, they can enjoy 3 units of surplus, so that the total surplus becomes
8. Actually, starting from any trading pair, we can find a path that leads to a Pareto
efficient allocation.
---------------------------------Figure 7 is around here---------------------------------In our bilateral trading experiment, every session had at least one subject who wasa buyer and a seller in the same session. Apparently, this dual role property helped to
improve the efficiency of allocation in all sessions. On the other hand, in the double
auction experiment, no sessions with marginal abatement cost curve disclosure had such a
subject, but every session with its closure had at least one such subject. In the double

15auction with the marginal abatement cost curve disclosure, every subject understood whoshould be a buyer and a seller from Figure 2, and hence no dual role trader was generated
during the auction. However, the dual role property was important to improve efficiency
in the double auction under the marginal abatement cost closure.
Most of the previous emissions trading experiments in the literature has not taken
account of the dual role property. For example, Cason and Gangadharan (1998) reported
that efficiencies are quite low in an experiment where subjects publicly post proposed
terms of trade through an Electronic Bulletin Board that captures the Regional Clean Air
Incentives Market (RECLAIM) in the Los Angeles area. Cason and Gangadharan partly
attribute this low efficiency to some transaction costs due to the Bulletin Board system.
We would conjecture that the dual role property may drastically improve its efficiency.
In both bilateral trading and double auction experiments, the variances ofweighted contracted prices around the beginning of transactions are quite large, but
toward the end the variances of weighted contracted prices in double auction sessions are
sufficiently smaller than those in bilateral trading sessions. Furthermore, we find that
contracted prices around the end of transactions in double auction sessions are muchcloser to the competitive equilibrium price than those in bilateral trading sessions. In
these respects, the double auction is better than bilateral trading.
As for the effect of marginal abatement cost disclosure, the variances of weighted
contracted prices with information disclosure are smaller than those with information
closure in double auction sessions. In bilateral trading, the former are smaller than thelatter if the contracted prices are not disclosed. The disclosure of contracted priceinformation in bilateral trading does not affect the variances of the contracted prices if theabatement cost information is revealed. Since the number of sessions in our experiments

16

is limited, we cannot conclude some definite effects. However, it seems that the
information of marginal abatement costs of other countries may reduce some variances ofcontracted prices in both bilateral trading and the double auction.
The experiments did not show any significant effects of disclosure of contracted
prices on the variance in bilateral trading. This does not necessarily imply that the closureof contracted prices is better than disclosure. First, if the disclosure or closure ofcontracted prices does not matter, there is no reason why they should be hidden.
Although the experimental results did not show any significant difference, something
unexpected might occur in future emissions trading. For this safety reason, transactions
should be undertaken in public. Second, the transaction of GHG emissions allowances is
not a truly private economic activity. As it would affect absolutely everyone, it should bedone in public.
As Figures 4-1, 4-2, and 6 show, the number of asks and bids in bilateral trading islarger than the number in the double auction. The average number in bilateral trading isabout four times as large as that in the double auction. If we think that this number is anindicator of economic transaction costs, we might conclude that the double auction isbetter than bilateral trading. However, this statement belies the fact that a large volume ofasks and bids can be transmitted through a computer network such as the internet at only
a nominal cost.
Subjects who played the U.S.A. role in the double auction experiment obtained agreater profit than they could have earned at the competitive equilibrium price. This does
not necessarily indicate that the subjects exercised market power. We conjecture that
subjects in the double auction may have much broader information on the market than thesubjects in bilateral trading since bids and asks are public in the double auction. This fact

17

might trigger the U.S.A. subjects to use their market power. Clearly, further studies areneeded to understand this market power issue.

5. Concluding Remarks
In these experiments, it was found that, first, the efficiency of both bilateral trading
and double auction is quite high. This high efficiency may come from the dual role
property of traders. Second, marginal abatement costs are equalized over time in bothtrading institutions. Third, contracted prices did not converge to the competitive priceover time in bilateral trading, but they converged relatively to the competitive price in the
double auction. Fourth, subjects who had market power did not use it in bilateral trading,but subjects who had market power in the double auction experiment obtained greater
profits than at the competitive price.
If a policy goal is only to achieve cost effectiveness, either institution can attainsuch a goal. On the other hand, if a policy maker cares about "equity," in the sense thatthe same unit of allowance must be traded with the same price, the double auction isbetter than bilateral trading. Furthermore, if one thinks that some transaction costs
increase as the number of asks and bids increases, the double auction is better thanbilateral trading.
Our comparison of two institutions is a prelude to several more experiments that
aim at designing the entire emissions trading institutions. In order to provide a solid basis
for such a design, we plan to conduct the following: (1) Banking experiment, (2) Noncompliance experiment, (3) Liability experiment and (4) Market power experiment.

18

REFERENCES
Bohm, Peter, A Joint Implementation as Emission Quota Trade: An Experiment Among Four
Nordic Countries, Nord 1997:4 by Nordic Council of Ministers, June, 1997.
Cason, Timothy N., "An Experimental Investigation of the Seller Incentives in the EPA's
Emission Trading Auction," American Economic Review 85(4), September 1995, pp.
905-22.
Cason, Timothy N. and Charles R. Plott, "EPA's New Emissions Trading Mechanism: A
Laboratory Evaluation," Journal of Environmental Economics and Management 30(2),March 1996, pp. 133-60.
Cason, Timothy N. and Lata Gangadharan, "An Experimental Study of Electronic Bulletin
Board Trading for Emission Permits," Journal of Regulatory Economics 14, 1998, pp. 5573.
Feldman, Allan M., "Bilateral Trading, Processes, Pairwise Optimality, and Pareto
Optimality," Review of Economic Studies 40(4), October 1973, pp. 463-73.
Godby, Robert W., Stuart Mestelman, and R. Andrew Muller, "Experimental Tests ofMarket Power in Emission Trading Markets," in Environmental Regulation and Market
Structure, Emmanuel Petrakis, Eftichios Sartzetakis, and Anastasios Xepapadeas(Eds.), Cheltenham, United Kingdom: Edward Elgar Publishing Limited,
forthcoming, September, 1998.
Hizen, Y., and T. Saijo, "Price Disclosure, Marginal Abatement Cost Information andMarket Power in a Bilateral GHG Emissions Experiment," unpublished manuscript,
ISER, Osaka University, 1999a.
Hizen, Y., and T. Saijo, "Comparing Bilateral Trading and Double Auction Institutions in
GHG Emissions: Experimental Results," unpublished manuscript, ISER, Osaka
University, 1999b.
Joskow, Paul L. Richard Schmalensee, and Elizabeth M. Bailey, "The Market for Sulfur
Dioxide Emissions," American Economic Review 88(4), September 1998, pp.669-685.

19

Muller, R. Andrew and Stuart Mestelman, "What Have We Learned From Emissions
Trading Experiments," mimeo., forthcoming in Managerial and Decision Economics,
July, 1998.
Stavins, Robert N., "What Can We Learn from the Grand Policy Experiment? Lessons
from SO2 Allowance Trading," Journal of Economic Perspectives 12(3), Summer, 1998,
pp.69-88.
Schmalensee, Richard, Paul L. Joskow, A. Denny Ellerman, Juan Pablo Montero, andElizabeth M. Bailey, "An Interim Evaluation of Sulfur Dioxide Emissions Trading,"
Journal of Economic Perspectives 12(3), Summer, 1998, pp.53-68.

20

Price250224
195This is a sample
graph. We will
distribute the graphthat you will use after
the instruction.

200
163
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46

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Quantity
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Price

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gain

revenueA

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Benefit

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Price

Buy!

Your position

Sell!

Your position
Price

Price
Profitgain

Benefitrevenue

Cost

Payment

Your position

No buy or no sell

Buy!
Your position

Sell!
Your position

Figure 1. A Sample Graph

1-Russia 2-Ukraine 3-USA 4-Poland 5-EU 6-Japan

2

1

3
(-45)

215

4
240
(-27)

216

(-80)

(-50)

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(-40)

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No country names were given to subjects in the experiment.

Figure 2. All Marginal Abatement Cost Curves

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1
0.9
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Efficiency

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OO1
OO2
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Min.
Figure 3. Efficiency over Time in Bilateral Trading

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280 Price

280 Price

Session OO1Seller Buyer
Quantity
Traded

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Session OX1

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ask

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1 Russia 2 Ukraine 3 USA
4 Poland 5 EU 6 Japan

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Session OX2

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Minutes

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MinutesFigure 4-1. Contracts, Asks and Bids in Bilateral Trading

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Minutes

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280 Price
260

Session XO1Seller Buyer
Quantity
Traded

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280 Price

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4 Poland 5 EU 6 Japan
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Minutes

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MinutesFigure 4-2. Contracts, Asks and Bids in Bilateral Trading

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1
0.9
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Efficiency

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O1

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Min.
Figure 5. Efficciency over Time in the Double Auction.

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280 Price

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Session X1

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Session O3

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Minutes

Seller Buyer
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Traded

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1 Russia 2 Ukraine 3 USA
4 Poland 5 EU 6 Japan
ask

bid

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MinutesFigure 6. Contracts, Asks and Bids in the Double Auction

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Price
12
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4
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0

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1

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2

Figure 7. The Dual Role Property

Quantity