An Options Pricing Approach for CO2 Allowances in the EU ETS
AbstractIf 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.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by CEPE Center for Energy Policy and Economics, ETH Zurich in its series CEPE Working paper series with number 09-64.
Length: 38 pages
Date of creation: Jun 2009
Date of revision:
Permit markets; air pollution; climate change; CO2; options pricing; EU ETS;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- 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)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Richard Newell & William Pizer & Jiangfeng Zhang, 2005.
"Managing Permit Markets to Stabilize Prices,"
Environmental & Resource Economics,
European Association of Environmental and Resource Economists, vol. 31(2), pages 133-157, 06.
- Bohringer, Christoph & Lange, Andreas, 2005.
"On the design of optimal grandfathering schemes for emission allowances,"
European Economic Review,
Elsevier, vol. 49(8), pages 2041-2055, November.
- Böhringer, Christoph & Lange, Andreas, 2003. "On the Design of Optimal Grandfathering Schemes for Emission Allowances," ZEW Discussion Papers 03-08, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
- Seifert, Jan & Uhrig-Homburg, Marliese & Wagner, Michael, 2008. "Dynamic behavior of CO2 spot prices," Journal of Environmental Economics and Management, Elsevier, vol. 56(2), pages 180-194, September.
- Sijm, J. & Neuhoff, K. & Chen, Y., 2006. "CO2 cost pass through and windfall profits in the power sector," Cambridge Working Papers in Economics 0639, Faculty of Economics, University of Cambridge.
- Jinhua Zhao, 2000.
"Irreversible Abatement Investment Under Cost Uncertainties: Tradable Emission Permits and Emissions Charges,"
Center for Agricultural and Rural Development (CARD) Publications
00-wp252, Center for Agricultural and Rural Development (CARD) at Iowa State University.
- Zhao, Jinhua, 2003. "Irreversible abatement investment under cost uncertainties: tradable emission permits and emissions charges," Journal of Public Economics, Elsevier, vol. 87(12), pages 2765-2789, December.
- Zhao, Jinhua, 2003. "Irreversible Abatement Investment Under Cost Uncertainties: Tradable Emission Permits and Emissions Charges," Staff General Research Papers 10223, Iowa State University, Department of Economics.
- Zhao, Jinhua, 2000. "Irreversible Abatement Investment Under Cost Uncertainties: Tradable Emission Permits And Emissions Charges," 2000 Annual meeting, July 30-August 2, Tampa, FL 21816, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
- Maria Mansanet-Bataller & Angel Pardo & Enric Valor, 2007. "CO2 Prices, Energy and Weather," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 73-92.
- Benz, Eva & Trück, Stefan, 2009. "Modeling the price dynamics of CO2 emission allowances," Energy Economics, Elsevier, vol. 31(1), pages 4-15, January.
- Wilfried Rickels & Vicki Duscha & Andreas Keller & Sonja Peterson, 2007. "The determinants of allowance prices in the European Emissions Trading Scheme - Can we expect an efficient allowance market 2008?," Kiel Working Papers 1387, Kiel Institute for the World Economy.
- Paul Leiby & Jonathan Rubin, 2001. "Intertemporal Permit Trading for the Control of Greenhouse Gas Emissions," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 19(3), pages 229-256, July.
- Schennach, Susanne M., 2000. "The Economics of Pollution Permit Banking in the Context of Title IV of the 1990 Clean Air Act Amendments," Journal of Environmental Economics and Management, Elsevier, vol. 40(3), pages 189-210, November.
- Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
- Alberola, Emilie & Chevallier, Julien & Cheze, Benoi^t, 2008. "Price drivers and structural breaks in European carbon prices 2005-2007," Energy Policy, Elsevier, vol. 36(2), pages 787-797, February.
- Cronshaw, Mark B & Brown-Kruse, Jamie, 1996. "Regulated Firms in Pollution Permit Markets with Banking," Journal of Regulatory Economics, Springer, vol. 9(2), pages 179-89, March.
- Rubin, Jonathan D., 1996. "A Model of Intertemporal Emission Trading, Banking, and Borrowing," Journal of Environmental Economics and Management, Elsevier, vol. 31(3), pages 269-286, November.
- Peter Alaton & Boualem Djehiche & David Stillberger, 2002. "On modelling and pricing weather derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(1), pages 1-20.
- Johann Wackerbauer & Jutta Albrecht-Saavedra & Marc Gronwald & Janina Ketterer & Jana Lippelt & Johannes Pfeiffer & Luise Röpke & Markus Zimmer, 2011. "Bewertung der klimapolitischen Maßnahmen und Instrumente: eine Studie im Auftrag der E.ON AG," ifo Forschungsberichte, Ifo Institute for Economic Research at the University of Munich, number 51, December.
- 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 33, Grantham Research Institute on Climate Change and the Environment.
- Marc Gronwald & Janina Ketterer, 2009. "Zur Bewertung von Emissionshandel als Politikinstrument," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 62(11), pages 22-25, 06.
- Beat Hintermann, 2011. "Market Power, Permit Allocation and Efficiency in Emission Permit Markets," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 49(3), pages 327-349, July.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Carlos Ordas).
If references are entirely missing, you can add them using this form.