Slow Focus: Belief Evolution in the U.S. Acid Rain Program


Chen, Cuicui. “Slow Focus: Belief Evolution in the U.S. Acid Rain Program.” Cambridge, MA: Harvard Environmental Economics Program, 2018.
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I study firm behavior in new markets by examining coal-dependent private electric utili-ties’ beliefs about the sulfur dioxide allowance price following the implementation of the U.S. Acid Rain Program. The program is the first large-scale cap-and-trade program, exposing the electric utility industry to a wholly novel market for pollution allowances. I estimate firms’ beliefs about the allowance price from 1995 to 2003 using a firm-level dynamic model of allowance trades, coal quality, and emission reduction investment. I find that firms ini-tially underestimate the role of market fundamentals as a driver of allowance prices, but over time their beliefs appear to converge toward the stochastic process of allowance prices. Such beliefs in the first five years of the program cost firms around 10% of their profits. Beliefs also change the relative efficiency of cap-and-trade programs and emission taxes.



Last updated on 10/15/2018