Equilibrium pricing of contingent claims in tradable permit markets

Kijima, Masaaki; Maeda, Akiko; Nishide, Kazuhiko

doi:10.1002/fut.20430

Cited by 35 publications

(12 citation statements)

References 23 publications

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“…A few studies investigate agents' optimal strategies and the properties of permit prices within stochastic frameworks that employ a stylized representation of an emission trading system and abstract from the specific design features of today's systems. In particular, these approaches consider emissions trading in a setting of one finite compliance period (Seifert, Uhrig-Homburg, and Wagner (2008), Carmona, Fehr, and Hinz (2009), Carmona, Fehr, Hinz, and Porchet (2010), and Chesney and Taschini (2012)) or under symmetric rules for banking and borrowing (Cetin and Verschuere (2009), Kijima, Maeda, and Nishide (2010)). 3 Because the value of emission permits only arises due to the regulatory rules of the system, we argue that it is crucial to account for the specific design of today's cap-and-trade systems to make clear-cut predictions about the behavior of permit prices and to derive implications for related derivatives.…”

Section: Introductionmentioning

confidence: 99%

Equilibrium Price Dynamics of Emission Permits

Hitzemann¹,

Uhrig‐Homburg

2018

J. Financ. Quant. Anal.

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This article presents a stochastic equilibrium model for environmental markets that allows us to study the characteristic properties of emission permit prices induced by the design of today’s cap-and-trade systems. We characterize emission permits as highly nonlinear contingent claims on economy-wide emissions and reveal their hybrid nature between investment and consumption assets. Our model makes predictions about the dynamics and volatility structure of emission permit prices, the forward price curve, and the implications for option pricing in this market. Empirical evidence from existing emissions markets shows that the model explains the stylized facts of emission permit prices and related derivatives.

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Section: Introductionmentioning

confidence: 99%

Equilibrium Price Dynamics of Emission Permits

Hitzemann¹,

Uhrig‐Homburg

2018

J. Financ. Quant. Anal.

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“…The economic premium principle approach was initiated by Bühlmann (1980). Since then, several researchers have applied the formula to price contingent claims (Iwaki et al 2001, Iwaki 2002, Kijima et al 2010, Takino 2016a. We note that the threshold is not used to evaluate the counterparty risk (or credit risk) and is only used to determine the collateral amount.…”

Section: Threshold and Net Exposurementioning

confidence: 99%

An Equilibrium Model for an Otc Derivative Market Under a Counterparty Risk Constraint

Takino

2018

J. Fin. Mngt. Mar. Inst.

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In this study, we develop an equilibrium pricing model for an option contract with a counterparty risk, a collateral agreement, a counterparty risk constraint, and a threshold. Since we consider the option market to be an example of the derivatives market, we suppose that the buyer of an option has only countertparty risk of a seller defaulting. In addition, we consider a model where the buyer is allowed to enter into an option contract within an allocated amount of risk capital for counterparty risk, and requires (cash) collateral to the seller if the exposure exceeds the threshold. The counterparty risk is measured as a credit valuation adjustment. We provide an equilibrium pricing rule and an equilibrium volume formula by solving participants’ static utility-maximization problems. Based on numerical simulations, we verify the mechanisms through which collateralization, risk capital, and the threshold affect the size of the over-the-counter (OTC) option market. Finally, we analyze the influence of the buyer’s risk-aversion on the market, without collateralization. The results imply that the risk constraint might be a proxy for an investor’s attitude towards risk.

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“…Some papers have considered explicitly risk-averse decision makers. One of them, [9], develops a pricing model for the spot and derivative pricing of environmental certificates in a single-period economy. In [7], the authors also develop a (multi-period) equilibrium pricing model for contingent claims depending on environmental certificates, where risk-averse agents maximize the expected utility of their profit function.…”

Section: Theory Of Marketable Pollution Rightsmentioning

confidence: 99%

Risk Aversion in Modeling of Cap-and-Trade Mechanism and Optimal Design of Emission Markets

Falbo

Hinz

2015

Stochastics of Environmental and Financial Economics

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According to theoretical arguments, a properly designed emission trading system should help reaching pollution reduction at low social burden based on the theoretical work of environmental economists, cap-and-trade systems are put into operations all over the world. However, the practice from emissions trading yields a real stress test for the underlying theory and reveals a number of its weak points. This paper aims to fill the gap between general welfare concepts underlying understanding of liberalized market and specific issues of real-world emission market operation. In our work, we present a novel technique to analyze emission market equilibrium in order to address diverse questions in the setting of risk-averse market players. Our contribution significantly upgrades all existing models in this field, which neglect risk-aversion aspects at the cost of having a wide range of singularities in their conclusions, now resolved in our approach. Furthermore, we show both how the architecture of an environmental market can be optimized under the realistic assumption of risk-aversion.

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Equilibrium pricing of contingent claims in tradable permit markets

Cited by 35 publications

References 23 publications

Equilibrium Price Dynamics of Emission Permits

Equilibrium Price Dynamics of Emission Permits

An Equilibrium Model for an Otc Derivative Market Under a Counterparty Risk Constraint

Risk Aversion in Modeling of Cap-and-Trade Mechanism and Optimal Design of Emission Markets

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