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Emissions Trading as a Policy InstrumentEvaluation and Prospects$
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Marc Gronwald and Beat Hintermann

Print publication date: 2015

Print ISBN-13: 9780262029285

Published to MIT Press Scholarship Online: January 2016

DOI: 10.7551/mitpress/9780262029285.001.0001

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Offset Spread Options in the European Carbon Market

Offset Spread Options in the European Carbon Market

(p.267) 11 Offset Spread Options in the European Carbon Market
Emissions Trading as a Policy Instrument

Timothy Fitzgerald

The MIT Press

Observers of the European Union Emissions Trading System have puzzled over the use, or lack thereof, of carbon offset credits. Emitters eschewed an arbitrage opportunity by forgoing these credits to account for verified emissions. Even though the spread option was in the money throughout the phase, emitters preferred to wait to exercise. Faced with the prospect of expiring options, the use of offsets increased later in the phase—especially in the final year. A simple model of compliance decisions is combined with a trinomial option pricing model to derive values of waiting in each year of the compliance period, and is then applied to the data on surrendering offset assets. Given the observed behavior, the model also yields implied volatilities regarding market expectations for allowance and offset price volatility. Those implied volatilities indicate the considerable uncertainty about the optimal decision to use offset assets.

Keywords:   carbon offsets, spread option, trinomial option, Emissions Trading System

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