Abstract

In this paper we study a pollution regulation problem in an electricity market with a network structure. The market is ruled by an independent system operator (ISO) who has the goal of reducing the pollutant emissions of the providers in the network by encouraging the use of cleaner technologies. The problem of the ISO formulates as a contracting problem with each one of the providers, who interact among themselves by playing a stochastic differential game. The actions of the providers are not observable by the ISO which faces the moral hazard. By using the dynamic programming approach, we represent the value function of the ISO as the unique viscosity solution to the corresponding Hamilton-Jacobi-Bellman equation. We prove that this solution is smooth and characterize the optimal controls for the ISO. Numerical solutions to the problem are presented and discussed. We consider also a simpler problem for the ISO, with constant production levels, that can be solved explicitly in a particular setting.