Modelling emission allowance prices

To stabilize the greenhouse gas concentrations in the atmosphere, market-based policy instruments are considered as effective solutions. Among these, the cap-and-trade systems are very popular and have been established over the globe. In most carbon markets, the European Union Emission Trading Scheme (EU ETS) has the largest scale. The regulatory framework of international and European emission trading scheme will be studied in this thesis. The benchmark product of EU ETS, the EUA futures contract, is largely traded. In the present research for pricing the carbon permits, reduced-form models have proved to be useful. The performance of the model proposed by Carmona and Hinz will be empirically analyzed. As evidence for a time-varying market price of risk can be found by applying statistical tests, the Carmona-Hinz framework can be extended by introducing a bivariate pricing model. This extended pricing model is able to extract information on the market price of risk and evaluate its impact on the EUA options. For international emission trading, linking emission trading systems have become a significant issue. This thesis develops a market equilibrium model on deterministic settings and investigates the price convergence behavior in trading schemes to be linked under different regimes. The model results explain the price convergence behavior on a quantitative basis, which coincide with the qualitative analysis of Grüll and Taschini.



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