Reference no: EM134822 , Length: 50

Dissertation writing help - Carbon Trading

Custom Dissertation Writing Service - Financial instrument

Carbon trading is seen as a financial instrument where markets will be used to lower greenhouse gas emissions like as carbon dioxide. With a good understanding of the stochastic carbon price dynamics, companies can hedge their positions, aggregate risk exposure or speculate on underlying price movements, and ultimately have the capacity to trade carbon derivatives. In this study we first begin a trading platform for a two-company development in a multi-period setting and derive an equilibrium carbon spot price. By using an Ornstein- Uhlenbeck process we can capture the mean-reversion characteristics related with carbon emissions which in turn allow us to simply extend the equilibrium spot price model to a multi-company development. We then suggest a stochastic differential equation to capture the behavior of the unique equilibrium spot price. In addition by using a no-arbitrage principle we can prepare a futures stochastic differential equation and hence derive under risk-neutral dynamics carbon options on futures. In particular by incorporating futures prices of electricity and natural gas we extend our findings by analyzing clean spark spread options. Finally we interpret the above findings with numerical results based on extensive Monte Carlo simulations.