Pricing emission permits in the absence of abatement

Beat Hintermann

Energy Economics, 2012, vol. 34, issue 5, 1329-1340

Abstract: 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.

Keywords: Emission permit market; EU ETS; Options pricing; Climate change; Air pollution (search for similar items in EconPapers)
JEL-codes: G12 Q52 Q53 Q54 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:34:y:2012:i:5:p:1329-1340

DOI: 10.1016/j.eneco.2012.06.005

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