Avoiding a Lemons Market by Including Uncertainty in the Kyoto Protocol: Same Mechanism - Improved Rules.

In its current form the Kyoto Protocol does not consider the issue of uncertainty in the process of mutual recognition of emission reductions between Parties. We argue that lack of appropriate institutions that police emission reporting will lead to a disintegration of the carbon market due to competition induced quality deterioration of reporting. The introduction of a verification clause in the Protocols rules would be a first step towards avoiding disintegrative tendencies and carry the potential of improving the Protocols effectiveness. Building on a physical approach of verification times we derive an economic model of optimal emission and uncertainty reduction to reach a verifiable emission target. In such a set-up, depending on its competitive advantage, a Party can choose to reduce emissions and/or the associated uncertainties or trade verified certificates. Thus, the proposed model is intended to help prioritize efforts to reach verifiable emission reductions with least costs within a Kyoto type framework.