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Pricing emission permits in the absence of abatement

  • Hintermann, Beat

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.

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Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 34 (2012)
Issue (Month): 5 ()
Pages: 1329-1340

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Handle: RePEc:eee:eneeco:v:34:y:2012:i:5:p:1329-1340
Contact details of provider: Web page: http://www.elsevier.com/locate/eneco

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  1. 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.
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