An Options Pricing Approach for CO2 Allowances in the EU ETS

Beat Hintermann

No 09-64, CEPE Working paper series from CEPE Center for Energy Policy and Economics, ETH Zurich

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.

Keywords: Permit markets; air pollution; climate change; CO2; options pricing; EU ETS (search for similar items in EconPapers)
JEL-codes: G12 G14 G18 Q52 Q53 Q54 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2009-06
New Economics Papers: this item is included in nep-ene, nep-env and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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