In this paper we advocate a new initial allocation mechanism for a tradable pollution permit market. We outline a Permit Allocation Contest (PAC) that distributes permits to ...rms based on their rank relative to other ...rms. This ranking is achieved by ordering ...rms based on an observable 'external action'where the external action is an activity or characteristic of the ...rm that is independent of their choice of emissions in the tradeable permit market. We show that this mechanism e¢

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... ly allocates permits and, as a result, the tradeable permit market is cost-e¤ective. We determine the symmetric equilibrium strategy of each ...rm in choosing their external action and ...nd the choice is in ‡uenced by the ...rm's cost structure and the regulator's choice of permit allocation schedule (distribution of permits to the market). Furthermore, we investigate the factors that determine the regulator's choice of optimal permit allocation schedules.