Optimal environmental policy under imperfect information

Abstract

The purpose of this paper is to examine the role of information structure in the design of the structure and parameters of an optimal regulatory mechanism. In particular, the paper analyzes both firm and public agency behavior under environmental externality internalization schemes and stochastic externality measurements of emissions and concentrations. It is shown that in general, the optimal environmental control policy involves the derivation of regulatory controls, measurement controls and the sequential estimation of inaccessible emissions and concentrations by a Kalman filter.