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Sustainability 2017, 9(2), 207; doi:10.3390/su9020207

Stochastic Differential Equation Models for the Price of European CO2 Emissions Allowances

1
School of Economics and Management, Fuzhou University, No. 2, Xueyuan Road, Daxue New District, Fuzhou District, Fuzhou 350108, China
2
Department of Mathematics and Statistics, University of Strathclyde, Glasgow G1 1XH, UK
*
Author to whom correspondence should be addressed.
Academic Editor: Yongrok Choi
Received: 8 October 2016 / Revised: 23 January 2017 / Accepted: 24 January 2017 / Published: 4 February 2017
(This article belongs to the Section Economic, Business and Management Aspects of Sustainability)
View Full-Text   |   Download PDF [643 KB, uploaded 4 February 2017]   |  

Abstract

Understanding the stochastic nature of emissions allowances is crucial for risk management in emissions trading markets. In this study, we discuss the emissions allowances spot price within the European Union Emissions Trading Scheme: Powernext and European Climate Exchange. To compare the fitness of five stochastic differential equations (SDEs) to the European Union allowances spot price, we apply regression theory to obtain the point and interval estimations for the parameters of the SDEs. An empirical evaluation demonstrates that the mean reverting square root process (MRSRP) has the best fitness of five SDEs to forecast the spot price. To reduce the degree of smog, we develop a new trading scheme in which firms have to hand many more allowances to the government when they emit one unit of air pollution on heavy pollution days, versus one allowance on clean days. Thus, we set up the SDE MRSRP model with Markovian switching to analyse the evolution of the spot price in such a scheme. The analysis shows that the allowances spot price will not jump too much in the new scheme. The findings of this study could contribute to developing a new type of emissions trading. View Full-Text
Keywords: CO2 emissions allowances; spot price; stochastic differential equations; parameter estimation; Markovian switching CO2 emissions allowances; spot price; stochastic differential equations; parameter estimation; Markovian switching
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Cai, W.; Pan, J. Stochastic Differential Equation Models for the Price of European CO2 Emissions Allowances. Sustainability 2017, 9, 207.

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