Carbon Emission Permit Price Volatility Reduction via Financial Options

34 Pages Posted: 18 Jul 2014

See all articles by Li Xu

Li Xu

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

Shijie Deng

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

Valerie Thomas

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

Date Written: October 16, 2012

Abstract

We develop a stylized model to investigate the impact of financial options on reducing carbon permit price volatility under a cap-and-trade system. The existence of an option market provides a mechanism to hedge the uncertainty of future spot prices and is a stimulus for investment in carbon emission abatement technologies. We show that both the spot price level and the price volatility of carbon permits can be reduced via the trading of financial options, while achieving the emission reduction target. We also show that introducing financial options in a banking environment offers more flexibility to risk management in carbon permit trading.

Keywords: Carbon permit trading, financial options, volatility mitigation, emission permit pricing

Suggested Citation

Xu, Li and Deng, Shijie and Thomas, Valerie, Carbon Emission Permit Price Volatility Reduction via Financial Options (October 16, 2012). Available at SSRN: https://ssrn.com/abstract=2467366 or http://dx.doi.org/10.2139/ssrn.2467366

Li Xu (Contact Author)

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

Shijie Deng

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

Valerie Thomas

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

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