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Equilibrium Price Dynamics of Emission Permits

47 Pages Posted: 17 Feb 2011 Last revised: 30 Apr 2015

Steffen Hitzemann

Rutgers, The State University of New Jersey - Rutgers Business School

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance

Date Written: September 2014

Abstract

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.

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

JEL Classification: G13, Q56, Q58, C61

Suggested Citation

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

Steffen Hitzemann (Contact Author)

Rutgers, The State University of New Jersey - Rutgers Business School ( email )

1 Washington Park
Newark, NJ 07102
United States

Marliese Uhrig-Homburg

Karlsruhe Institute of Technology (KIT) - Institute for Finance ( email )

P.O. Box 6980
D-76049 Karlsruhe, DE
Germany
+49 721 6084 8183 (Phone)
+49 721 6084 8190 (Fax)

HOME PAGE: http://derivate.fbv.kit.edu/english/index.php

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