Abstract
CO 2 emission allowances are traded nowadays over the counter (OTC) and on exchanges across the European Union (EU). It thus becomes increasingly important for traders of these emission certificates to have a valid CO 2 spot price model to value potential derivatives. In addition, CO 2-emitting companies require an adequate CO 2 spot price model in order to better assess their production costs and support emissions-related investment decisions. However, sufficient price history is still lacking for the European Union emission trading scheme (EU ETS). We therefore present a tractable stochastic equilibrium model reflecting stylized features of the EU ETS and analyze the resulting CO 2 spot price dynamics. Our main findings are that CO 2 prices do not have to follow any seasonal patterns, discounted prices should possess the martingale property, and an adequate CO 2 price process should exhibit a time- and price-dependent volatility structure. A brief empirical examination regarding market efficiency complements our analysis.
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