Integrated EUA and CER price modeling and application for spread option pricing

Pauline Barrieu and Max Fehr

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: In this paper we propose a market consistent futures price dynamics model for cap-andtrade schemes, designed in the spirit of the European Union’s Emissions Trading Scheme (EU ETS). Historical price dynamics for the EU ETS suggest that, both, European emission Allowances (EUAs) and Certified Emission Reductions (CERs), certificates, which are generated through the Clean Development Mechanism (CDM) - a non-domestic offset mechanism - are significantly related. We use an equilibrium framework to demonstrate that compliance regulation singles out special joint futures price dynamics. Based on this result we propose an arbitrage free futures price model and apply it to the pricing of spread options between EUAs and CERs.

Keywords: environment; asset pricing; stochastic model applications; markov processes; economics (search for similar items in EconPapers)
JEL-codes: D58 Q56 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2011-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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