R&D by asymmetric firms competing à la Cournot. Pollution rights are allocated by
the regulator, and firms can trade pollution permits. Both R&D competition and
R&D cooperation are considered; in the latter case, firms fully share information about
technologies. In a 3-stage game, firms first invest in R&D, then trade permits, and
then compete in output. The strategic interaction between different types of R&D
investments is analyzed. It is found that the permit price depends on total permits
only, not on their initial allocations. The optimal allocation of pollution rights by the
social planner is also considered; the allocation of permits between firms matters for
social welfare in the presence of environmental R&D under noncooperative R&D, but
is irrelevant under cooperative R&D. Moreover, it is optimal to give firms less permits
when spillovers are higher. In addition, grandfathering permits is studied under R&D
noncooperation. Furthermore, an R&D budget constraint is introduced. When the
constraint is binding, firms underinvest more in standard R&D than in environmental
R&D.