Transaction cost and market power affect the cost effectiveness of carbon markets． Will different carbon emission permit allocation methods result in different efficiency losses? This paper explores whether the choice of emission permit allocation method affects the cost effectiveness of ETS when transaction cost and market power exist in the carbon market． Our theoretical model shows that transaction cost leads to the efficiency loss of ETS and that the efficiency loss from benchmarking and grandfathering are less than auctioning． When there is only market power in the carbon market，the efficiency loss is proportional to the gap between the market power firm’s carbon emissions and its free emission permits． If both transaction cost and market power exist in the carbon market，market power further exacerbates the efficiency loss caused by transaction cost． The additional efficiency loss caused by grandfathering and benchmarking are less than that by auctioning． Policy makers are suggested to apply grandfathering or benchmarking to allocating emission permits to firms with market power and to cancel transaction-based fee in the carbon market．