Risk management in carbon trading : managing the risk of European CO2 allowance trading under the EU-ETS

Brouwers, Duco (2006) Risk management in carbon trading : managing the risk of European CO2 allowance trading under the EU-ETS.

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Abstract:In this study we tried to accomplish three things. First we aimed to give insight into the basic principles of emission mitigation. After explaining the theory of emission allowance trading we described the European emission market. We concluded that it is essential for the market to be fundamentally short. Recent reports that suggest the market is actually long resulted in an incredible price crash. We identified the fundamental price drivers and described their dynamics. We found that particularly returns on British gas have shown periods of high correlation with CO2 allowances (up to 70%). For other carbon emission related fuels we found no obvious correlations. We used a GARCH(1,1) model to forecast the volatility of a CO2 emission contract. The forecasts were then used in an advanced Value at Risk framework that is based on the empirical distribution. The out of sample back testing, revealed that the performance of the CHISVaR model is superior over the simple rolling Value at Risk. Based on the test results we concluded this approach deserves more attention, since it benefits both from the model free empirical distribution and the state of the art GARCH model.
Item Type:Essay (Master)
Clients:
Rabobank International
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Industrial Engineering and Management MSc (60029)
Link to this item:http://purl.utwente.nl/essays/58133
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