Many governments are addressing climate change by managing carbon emissions through a system of permits, sold in auctions at a uniform price — or the lowest winning bid, which represents the price that all winning bidders typically pay for each unit. New research by MIT Sloan School of Management associate professor Negin Golrezaei suggests that switching to a pay-as-bid auction, where each buyer pays the price they bid, could boost revenue and provide stronger incentives for companies to invest in greener technologies.

“The social cost of carbon is estimated at $190 per ton by the U.S. Environmental Protection Agency, yet auction prices often fall far short of this figure,” said  MIT Sloan School of Management associate professor Negin Golrezaei. “By adopting a market-driven approach like pay-as-bid auctions, we could better align permit prices with the true societal cost of carbon, making carbon markets more effective in driving emissions reductions.”

A key contribution of Golrezaei’s research is the development of an adaptable algorithm that addresses market dynamics. Until now, effectively evaluating the market under pay-as-bid auctions has been difficult due to the repeated interactions among participants — including power generation companies, industrial facilities, and the aviation sector — which influences market dynamics, revenue, and overall welfare. Repeated interactions can also create opportunities for collusion further complicating the design of these markets. This novel data-driven approach overcomes these challenges, enabling companies to learn how to bid effectively in this competitive environment.

“Our algorithm not only helps companies refine their bidding strategies but also offers valuable insights into the dynamics of the auction itself— how each bid is influenced by and influences others. Understanding these dynamics is crucial for assessing the potential impact of pay-as-bid auctions in carbon markets,” said Golrezaei. 

—

Source: MIT Sloan