An Options Pricing Approach for CO2 Allowances in the EU ETS

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An Options Pricing Approach for CO2 Allowances in the EU ETS

Author Info

Beat Hintermann () (Center for Energy Policy and Economics CEPE, Department of Management, Technology and Economics, ETH Zurich, Switzerland)

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Beat Hintermann

Abstract

If firms are unable to fully control their emissions, the cap in a permit market may be exceeded. Using stochastic aggregate emissions as the underlying I derive an options pricing formula that expresses the permit price as a function of the penalty for noncompliance and the probability of a binding cap. I apply my model to the EU ETS, where rapid market setup made it difficult for firms to adjust their production technology in time for phase 1. The model fits the data well, implying that the permit price was driven by firms hedging against stochastic emissions rather than marginal abatement costs.

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Publisher Info
Paper provided by CEPE Center for Energy Policy and Economics, ETH Zürich in its series CEPE Working paper series with number 09-64.

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Length: 38 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:cee:wpcepe:09-64

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
Q52 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Pollution Control 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

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-10-24 (All new papers)
NEP-ENE-2009-10-24 (Energy Economics)
NEP-ENV-2009-10-24 (Environmental Economics)
NEP-MIC-2009-10-24 (Microeconomics)

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This page was last updated on 2009-11-30.

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