Abstract
In this paper the authors introduce a joint model for the electricity spot and the emission market in Germany. The model is used to simulate the effects of changing market parameters and policy implications. They propose a structural approach to connect fundamental factors, such as demand, capacity, fuel prices and emission allowances, to the price of electricity. Based on empirical bid behavior of electricity producers in day-ahead auctions they develop a novel CO2 emission rate model. In order to introduce a feedback of CO2 allowances to the actual emission of greenhouse gases, a forward-backward stochastic differential equation is used to deduce a partial differential equation to price emission allowances. The resulting equation will be solved by an alternating direction implicit finite difference scheme.
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