European Union Emission Trading Scheme: A Model for Valuation and Hedging of Emission Unit Allowances Derivatives

Abstract
The European Union C02 Allowances (EUAs) are traded on several markets with increasing
intensity. The market structure derived from the Kyoto Protocol regulations is presented in
the paper. The aims of this thesis are to develop a price estimation model of European
Union Emission Allowances (EUAs) and risk management methods for companies
participating in the EUA market. Statistical and econometrical analysis on spot prices are
performed in order to assess the main characteristics of the price dynamics that need to be
incorporated in the model. A stochastic volatility model with a jump component is
implemented in a VBA framework, through a Monte Carlo simulation. The model is tested
for pricing and hedging against the Bluenext and European Climate Exchange (ECX) prices.