CO2 Emission Allowances Trading in Europe - Specifying a New Class of Assets

In the context of controlling greenhouse gas emissions, the directive on an EU-wide trading scheme for carbon dioxide (CO2) emission allowances may be considered as one of the major steps towards reducing environmental burden. A major question for market participants will be about regarding the price behavior of this new environmental asset. Due to non-maturity of the market, political regulations, fundamentals and certain characteristics of CO2 allowances it can be assumed that parameters for the price process or even the process itself changes through time. In this paper we review the stylized facts of emission allowances and come up with suggestions to model their price behavior adequately. We conduct a preliminary empirical analysis of CO2 allowance spot prices supporting our theoretical findings.

[1]  M. Cropper,et al.  Sulfur Dioxide Control by Electric Utilities: What Are the Gains from Trade? , 1998, Journal of Political Economy.

[2]  A. Ellerman,et al.  The Declining Trend in Sulfur Dioxide Emissions: Implications for Allowance Prices☆ , 1998 .

[3]  Eduardo S. Schwartz.  The stochastic behavior of commodity prices: Implications for valuation and hedging , 1997 .

[4]  D. Pilipović,et al.  Energy Risk: Valuing and Managing Energy Derivatives , 1997 .

[5]  Svetlozar T. Rachev,et al.  Stable modeling of different European power markets , 2005 .

[6]  R. Huisman,et al.  Regime Jumps in Electricity Prices , 2001 .

[7]  T. Tietenberg.  Economic Instruments for Environmental Regulation , 1990 .

[8]  A. Denny Ellerman,et al.  Markets for Clean Air , 2005 .

[9]  J. Rubin.  A model of intertemporal emission trading, banking, and borrowing , 1996 .

[10]  Dallas Burtraw,et al.  THE SO2 EMISSIONS TRADING PROGRAM: COST SAVINGS WITHOUT ALLOWANCE TRADES , 1996 .

[11]  Jonathan Rubin,et al.  Bankable Permits for the Control of Environmental Pollution , 1997 .

[12]  I. Simonsen.  Measuring anti-correlations in the nordic electricity spot market by wavelets , 2001, cond-mat/0108033.

[13]  Richard L. Ottinger,et al.  Compendium of Sustainable Energy Laws: Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 Establishing a Scheme for Greenhouse Gas Emission Allowance Trading Within the Community and Amending Council Directive 96/61/EC , 2005 .

[14]  R. Weron,et al.  Modelling Electricity Prices: Jump Diffusion and Regime Switching , 2004 .

[15]  Karlsruhe Fraunhofer-Institut für Systemtechnik und Innovationsforschung.  Flexible Fertigungssysteme und -zellen im Rahmen neuer Fabrikstrukturen in der Bundesrepublik Deutschland: Abschlußbericht zum deutschen Teil der im Auftrag der EG durchgeführten Projekte , 1987 .

[16]  S. Goldfeld,et al.  A Markov model for switching regressions , 1973 .

[17]  Susanne M. Schennach,et al.  The Economics of Pollution Permit Banking in the Context of Title IV of the 1990 Clean Air Act Amendments , 2000 .

[18]  E. M. Bailey,et al.  Markets for Clean Air: The U.S. Acid Rain Program , 2000 .

[19]  Chang‐Jin Kim,et al.  State-Space Models with Regime-Switching: Classical and Gibbs Sampling Approaches with Applications , 1999 .

[20]  Karan Bhanot,et al.  Behavior of power prices: implications for the valuation and hedging of financial contracts , 2000 .