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Carbon emission permit price volatility reduction through financial options

Author

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  • Xu, Li
  • Deng, Shi-Jie
  • Thomas, Valerie M.

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.

Suggested Citation

  • Xu, Li & Deng, Shi-Jie & Thomas, Valerie M., 2016. "Carbon emission permit price volatility reduction through financial options," Energy Economics, Elsevier, vol. 53(C), pages 248-260.
    • Handle: RePEc:eee:eneeco:v:53:y:2016:i:c:p:248-260
    DOI: 10.1016/j.eneco.2014.06.001
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    9. Fang, Guochang & Lu, Longxi & Tian, Lixin & he, Yu & Yin, Huibo, 2020. "Research on the influence mechanism of carbon trading on new energy—A case study of ESER system for China," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 545(C).
    10. Javad Khazaei & Michael Coulon & Warren B. Powell, 2017. "ADAPT: A Price-Stabilizing Compliance Policy for Renewable Energy Certificates: The Case of SREC Markets," Operations Research, INFORMS, vol. 65(6), pages 1429-1445, December.
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    More about this item

    Keywords

    Carbon permit trading; Financial options; Volatility mitigation; Emission permit pricing;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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