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Equilibrium Price Dynamics of Emission Permits

Steffen Hitzemann

University of Pennsylvania - Finance Department; Karlsruhe Institute of Technology (KIT)

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Financial Engineering and Derivatives Department

August 2014

This paper presents a stochastic equilibrium model for environmental markets that allows us to study the characteristic properties of emission permit prices induced by the design of today's cap-and-trade systems. We characterize emission permits as highly nonlinear contingent claims on economy-wide emissions and reveal their hybrid nature between investment and consumption assets. Our model makes predictions about the dynamics and volatility structure of emission permit prices, the futures price curve, and the implications for option pricing in this market. Empirical evidence from existing emissions markets shows that the model explains the stylized facts of emission permit prices and related derivatives.

Number of Pages in PDF File: 47

Keywords: emission permits, spot and futures price dynamics, carbon derivatives

JEL Classification: G13, Q56, Q58, C61

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Date posted: February 17, 2011 ; Last revised: November 18, 2014

Suggested Citation

Hitzemann, Steffen and Uhrig-Homburg, Marliese, Equilibrium Price Dynamics of Emission Permits (August 2014). Available at SSRN: http://ssrn.com/abstract=1763182 or http://dx.doi.org/10.2139/ssrn.1763182

Contact Information

Steffen Hitzemann (Contact Author)
University of Pennsylvania - Finance Department ( email )
The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
Karlsruhe Institute of Technology (KIT) ( email )
Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Marliese Uhrig-Homburg
Karlsruhe Institute of Technology (KIT) - Financial Engineering and Derivatives Department ( email )
D-76128 Karlsruhe, DE 76128
+49 721 6084 8183 (Phone)
+49 721 6084 8190 (Fax)
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References:  39
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