Integrated EUA and CER price modeling and application for spread option pricing
Abstract of Working Paper 50
Also known as Munich Re Technical Paper 7
In this paper, we propose a market consistent futures price dynamics model for cap-and-trade schemes, designed in the spirit of the European Union's Emissions Trading Scheme (EU ETS).
Historical price dynamics for the EU ETS suggest that both European emission Allowances (EUAs) and Certified Emission Reductions (CERs) certificates, which are generated through the Clean Development Mechanism (CDM) - a non-domestic offset mechanism - are significantly related.
We use an equilibrium framework to demonstrate that compliance regulation singles out special joint futures price dynamics.
Based on this result, we propose an arbitrage-free futures price model, and apply it to the pricing of spread options between EUAs and CERs.