Nonlinear dynamic pollution under uncertainty and binding targets

In this paper, we study the effects of environmental regulation which establishes binding targets to pollution accumulation. Pollution follows a geometric Brownian motion. Inside the targets, pollution behaves as if it were freely floating until it hits one of the two limits. The model provides three main results. First, we show that targets can affect pollution accumulation even when they are slack at the current time. Solutions of the model show that pollution becomes an S-shaped locus of the fundamentals. Second, we show that binding targets will lead to more stable pollution rate determination within the boundaries, than free floating. Finally, stabilization of pollution stock is related to the credibility of the regulator in defending the targets.