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.
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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)
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