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Pricing And Hedging In Carbon Emissions Markets


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    (Department of Statistics, London School of Economics, Houghton Street, London WC2A 2AE, UK)


    (Electrabel Trading and Portfolio Management, 8 Regentlaan, 1000 Brussels, Belgium)

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    We propose a model for trading in emission allowances in the EU Emission Trading Scheme (ETS). Exploiting an arbitrage relationship we derive the spot prices of carbon allowances given a forward contract whose price is exogenous to the model. The modeling is done under the assumption of no banking of carbon allowances (which is valid during the Phase I of Kyoto protocol), however, we also discuss how the model can be extended when banking of permits is available. We employ results from filtering theory to derive the spot prices of permits and suggest hedging formulas using a local risk minimisation approach. We also consider the effect of intermediate announcements regarding the net position of the ETS zone on the prices and show that the jumps in the prices can be attributed to information release on the net position of the zone. We also provide a brief numerical simulation for the price processes of carbon allowances using our model to show the resemblance to the actual data.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 12 (2009)
    Issue (Month): 07 ()
    Pages: 949-967

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    Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:07:p:949-967

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    Keywords: CO2 emission allowances; EU ETS; incomplete information; stochastic filtering; minimal martingale measure;

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    Cited by:
    1. Georg Grüll & Luca Taschini, 2010. "A comparison of reduced-form permit price models and their empirical performances," LSE Research Online Documents on Economics 37603, London School of Economics and Political Science, LSE Library.
    2. Luis M. Abadie & José M. Chamorro, 2011. "Valuing Expansions of the Electricity Transmission Network under Uncertainty: The Binodal Case," Energies, MDPI, Open Access Journal, vol. 4(10), pages 1696-1727, October.
    3. Lukas, Elmar & Welling, Andreas, 2014. "Timing and eco(nomic) efficiency of climate-friendly investments in supply chains," European Journal of Operational Research, Elsevier, Elsevier, vol. 233(2), pages 448-457.
    4. Julien Chevallier, 2014. "Review of the Stochastic Properties of CO2 Futures Prices," Working Papers 2014-565, Department of Research, Ipag Business School.
    5. Juri Hinz & Alex Novikov, 2010. "On fair pricing of emission-related derivatives," Papers 1011.5792,
    6. Julien Chevallier & Benoît Sévi, 2014. "On the Stochastic Properties of Carbon Futures Prices," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 58(1), pages 127-153, May.
    7. Hintermann, Beat, 2012. "Pricing emission permits in the absence of abatement," Energy Economics, Elsevier, Elsevier, vol. 34(5), pages 1329-1340.
    8. Georg Grüll & Luca Taschini, 2010. "A comparison of reduced-form permit price models and their empirical performances," Grantham Research Institute on Climate Change and the Environment Working Papers, Grantham Research Institute on Climate Change and the Environment 33, Grantham Research Institute on Climate Change and the Environment.


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