Dynamic behavior of CO2 spot prices

CO2 emission allowances are traded nowadays over the counter (OTC) and on exchanges across the European Union (EU). It thus becomes increasingly important for traders of these emission certificates to have a valid CO2 spot price model to value potential derivatives. In addition, CO2-emitting companies require an adequate CO2 spot price model in order to better assess their production costs and support emissions-related investment decisions. However, sufficient price history is still lacking for the European Union emission trading scheme (EU ETS). We therefore present a tractable stochastic equilibrium model reflecting stylized features of the EU ETS and analyze the resulting CO:, spot price dynamics. Our main findings are that CO2 prices do not have to follow any seasonal patterns, discounted prices should possess the martingale property, and an adequate CO2 price process should exhibit a time- and price-dependent volatility structure. A brief empirical examination regarding market efficiency complements our analysis. (C) 2008 Elsevier Inc. All rights reserved.