How can carbon trading price distortion be corrected? An empirical study from China's carbon trading pilot markets

The essence of carbon trading is to optimize the allocation of factor resources by using price leverage. However, the effect of the carbon trading market might be seriously affected by carbon trading price distortion (CTPD), which means the deviation of the actual trading price from the carbon marginal abatement cost (MAC). This paper proposes a novel analytical framework to evaluate the impacts of CTPD and explore corresponding correction strategies. Specifically, the impacts of CTPD are analyzed theoretically, and then CTPD in China's carbon trading pilot markets during 2013-2017 is evaluated by the Stochastic Frontier Analysis. Last, the panel data vector autoregression model and panel data vector error correction model are used to explore correction strategies. Our analysis reveals several interesting insights. First, our results show that CTPD negatively impacts the economic benefits, environmental benefits, and policy acceptance of the carbon trading market. Second, China's carbon trading market suffers from not only CTPD but also persistent negative price distortions in energy, labor, and capital factors, although CTPD is the most serious issue. Third, the energy price and macroeconomic environment have positive impacts on the carbon trading price. Last, a greater of any factor price distortion would lead to an increase in the carbon MAC. Based on these results, several correction strategies are recommended.