Inderscience Publishers

Review of the stochastic properties of CO 2 futures prices

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In this paper, we review the extant mathematical and environmental economics literatures on the stochastic properties of CO
2
emission allowance futures prices. We explain the main findings arising from this literature from both continuous- and jump-diffusion models. Based on the activity signature function, by Todorov and Tauchen (2010, 2011), our review shows that the Brownian motion shall be dismissed when modelling CO
2
futures, in sharp contrast with the bulk of previous literature on this topic. The central result is that the evolution of the carbon futures price can be described in terms of a pure jump-diffusion process. For instance, important cases of information shocks leading to allowance price jump can be addressed when modelled as an appropriately sampled, centred Lévy or Poisson process.

Keywords: carbon futures, stochastic modelling, jumps, activity signature function

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