Price Discovery in Cap-and Trade Markets for Fisheries

Price Discovery in Cap-and. Trade Markets for Fisheries Christopher M. Anderson (joint work with Jon G. Sutinen) University of Rhode Island (Visiting UAA Fall 2007) Funded by Rhode Island Sea Grant

New Markets • Cap-and-trade systems create brand new assets – Market must identify prices • New asset markets are prone to volatility and speculation – IPO stock prices fluctuate considerably – Experimental asset markets demonstrate speculative bubble-crash cycles

Volatility is Bad • Speculation can raise prices artificially • Poor price signals lead to poor participation and capitalization decisions • Puts at risk substantial portions of harvesters’ wealth – May support consolidation if larger operators can better diversify risk • Leads to political opposition to marketbased management

Improving Price Discovery • The rules of trade can be chosen to facilitate faster price discovery – Who may trade, when, how much, how often – What is traded, and what is the currency – How trade is facilitated by market • Do you really need designer markets? – Theory doesn’t say yes – In practice, know different institutions provide different incentives for revealing information • Have different price discovery properties

Why Experimental Testbedding? • Controlled test of predictions of economic models underlying proposed regulatory mechanisms • Cheaply and quickly evaluate economic properties of proposed program elements – Supply, demand profit functions are known, making possible precise comparisons of efficiency and other criteria – Results can be replicated, following scientific method – Identify flaws or potential issues in proposals before implementation and high-value or irreversible decisions are made – Differences among market designs not informed by theory, but loom large in determining outcomes – Past experience with FCC auctions, and water and pollution permit markets (and AK crab rationalization!) indicates experiments can improve field outcomes

Motivating Case • Transferable trap certificate program in RI lobster fishery – 280 owner-operated vessels – Regulated by limited access, but allowed access at the same level – Stock decreasing due to unknown factors, and overfishing

Experimental Design • 12 -14 student subjects earn profit (from fishing) based on the allowance held – Profit functions roughly based on 2001 medium-large operation • Allowance = ‘Permit’ – An entitlement to fish a fixed number of traps • Permit has life of 4 periods – Trade allowance during each period – Profit determined by allowance held at end of period • Stock assumed to be in steady state under TAC • Trade using a double auction • Series of 4 periods repeated three times • Subjects’ earnings paid to them in cash – Average $23, range $11 -$33 for about 2 hours

Results • Prices only weakly reflect marginal value of allowance – Evidence for speculative bubbles • Subjects reported within-period speculating • Weak bubble-shaped price patterns across periods

Results • Prices only weakly reflect marginal value of allowance – Evidence for speculative bubbles • Subjects reported within-period speculating • Bubble-shaped price patterns across periods – Price discovery is very hard • Noisy market with large number of trades • Parallels FL, NZ experience where price discovery was poor and many fishers became unhappy with program

Market with Initial Lease • In first round of trading, allow only leasing – Trades do not carry over from one period to the next

What Have We Learned? • In cap-and-trade markets: – Newly created asset markets can be highly volatile – Initial lease periods facilitate price discovery • Rules of trade do affect outcomes – Policymakers must include institutional effects in analysis of new policies – Value of past experiences may be limited to institution • Identify institution which works well, rather than restricting on which does not – Provides new degree of freedom for controlling outcomes

Market Design Elements • Pre-trading price signals – Leasing periods, or auctions • Multi-market – Simultaneous markets for joint or substitute products – Simultaneous lease markets – Two-pie systems • What is traded: Leases, poundage, shares, inputs • What is the currency: Money, catch shares • Experiments can be useful in assessing institutions – Policy analysts need new tool because no received theory – Experiments may be “best available science”