Modelling Multiperiod Carbon Markets Using Singular Forward-Backward SDEs

DOI10.1287/MOOR.2022.1269arXiv2008.09044OpenAlexW3068945438MaRDI QIDQ6199249FDOQ6199249

Authors: Jean-Francois Chassagneux, Hinesh Chotai, Dan Crisan

Publication date: 23 February 2024

Published in: Mathematics of Operations Research (Search for Journal in Brave)

Abstract: We introduce a model for the evolution of emissions and the price of emissions allowances in a carbon market such as the European Union Emissions Trading System (EU ETS). The model accounts for multiple trading periods, or phases, with multiple times at which compliance can occur. At the end of each trading period, the participating firms must surrender allowances for their emissions made during that period, and additional allowances can be used for compliance in the following periods. We show that the multi-period allowance pricing problem is well-posed for various mechanisms (such as banking, borrowing and withdrawal of allowances) linking the trading periods. The results are based on the analysis of a forward-backward stochastic differential equation with coupled forward and backward components, a discontinuous terminal condition and a forward component that is degenerate. We also introduce an infinite period model, for a carbon market with a sequence of compliance times and with no end date. We show that, under appropriate conditions, the value function for the multi-period pricing problem converges, as the number of periods increases, to a value function for this infinite period model, and that such functions are unique.

Full work available at URL: https://arxiv.org/abs/2008.09044

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zbMATH Keywords

decoupling field carbon markets forward-backward systems emission trading systems market stability reserve multiple compliance periods

Mathematics Subject Classification ID

Applications of stochastic analysis (to PDEs, etc.) (60H30) Financial applications of other theories (91G80)

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