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Pricing emission permits in the absence of abatement

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  • Hintermann, Beat

Abstract

If emissions are stochastic and firms are unable to control them through abatement, the cap in a permit market may be exceeded, or not be reached. I derive a binary options pricing formula that expresses the permit price as a function of the penalty for noncompliance and the probability of an exceeded cap under the assumption of no abatement. I apply my model to the EU ETS, where the rapid introduction of the market made it difficult for firms to adjust their production technology in time for the first phase. The model fits the data well, implying that the permit price may have been driven by firms hedging against stochastic emissions.

Suggested Citation

  • Hintermann, Beat, 2012. "Pricing emission permits in the absence of abatement," Energy Economics, Elsevier, vol. 34(5), pages 1329-1340.
    • Handle: RePEc:eee:eneeco:v:34:y:2012:i:5:p:1329-1340
    DOI: 10.1016/j.eneco.2012.06.005
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Will Gans & Beat Hintermann, 2013. "Market Effects of Voluntary Climate Action by Firms: Evidence from the Chicago Climate Exchange," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 55(2), pages 291-308, June.
    2. Hintermann, Beat & Peterson, Sonja & Rickels, Wilfried, 2014. "Price and market behavior in Phase II of the EU ETS," Kiel Working Papers 1962, Kiel Institute for the World Economy (IfW Kiel).
    3. John Sherwood & Michael Carbajales-Dale & Becky Roselius Haney, 2020. "Putting the Biophysical (Back) in Economics: A Taxonomic Review of Modeling the Earth-Bound Economy," Biophysical Economics and Resource Quality, Springer, vol. 5(1), pages 1-20, March.
    4. Beat Hintermann & Marc Gronwald, 2019. "Linking with Uncertainty: The Relationship Between EU ETS Pollution Permits and Kyoto Offsets," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 74(2), pages 761-784, October.
    5. Friedrich, Marina & Mauer, Eva-Maria & Pahle, Michael & Tietjen, Oliver, 2020. "From fundamentals to financial assets: the evolution of understanding price formation in the EU ETS," EconStor Preprints 196150, ZBW - Leibniz Information Centre for Economics, revised 2020.
    6. Balietti, Anca Claudia, 2016. "Trader types and volatility of emission allowance prices. Evidence from EU ETS Phase I," Energy Policy, Elsevier, vol. 98(C), pages 607-620.
    7. Beat Hintermann, 2017. "Market Power in Emission Permit Markets: Theory and Evidence from the EU ETS," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 66(1), pages 89-112, January.

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    More about this item

    Keywords

    Emission permit market; EU ETS; Options pricing; Climate change; Air pollution;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • Q52 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Pollution Control Adoption and Costs; Distributional Effects; Employment Effects
    • Q53 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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