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Description:
We study the endogenous formation of climate coalitions linked to a preferential free trade arrangement. In a multi-stage strategic trade and participation game, coalition and fringe countries dispose of a discriminatory tariff on dirty imports as well as emission permits imposed on domestic producers and traded on a common permit market inside the coalition, or respectively local markets outside. The participation game is solved by Monte-Carlo simulation, while the general equilibrium and the policy game are solved analytically. We find that preferential free trade can create effective climate coalitions in terms of depth and breadth.