On Fair Pricing Of Emission-related Derivatives

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Executive Summary

The climate rescue is on the top of many agendas. In this context, emission trading schemes are considered as promising tools. The regulatory framework of an emission trading scheme introduces a market for emission allowances and creates need for risk management by appropriate financial contracts. In this paper, the authors address logical principles underlying their valuation. The generic principle of an emission trading scheme is based on the so-called cap and trade mechanism. In this paper, an authority allocates fully tradable credits among responsible installations. At pre-settled compliance dates, each source must have enough allowances to cover all its recorded emissions, or be subject to penalties.

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