Modeling risk-neutral allowance price evolution with applications to option pricing

Juri Hinz
National University of Singapore

The climate rescue is on the top of many agendas. In this context, emission trading schemes
are considered as promising tools. The regulatory framework of an emission trading scheme
introduces a market for emission allowances and creates need for risk management by appropriate
financial contracts. We address logical
principles underlying the fair valuation of such derivatives.
Starting from the equilibrium of a market with risk averse players, we show that the
risk-neutral allowance price dynamics can be characterized in terms of a
fixed point equation which plays the same role as the central planer optimal
control problem for the non-risk averse situation. We show that derivatives valuation is naturally addressed in and can be obtained in this setting.

Presentation (PDF File)

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