January 23, 2011

Carbon Derivatives: A Destabilizing or a Virtuous Mechanism to Build a Carbon-Free Economy? The Example of the European CO2 Trading Scheme

by Arnaud Leconte and Tiziana Pagano

- Carbon derivatives could have a strong positive effect in multiplying resources. At the same time they are also a strong transmission mechanism to concentrate risks into banks and back to non-financial actors. However, in the current European Emission Trading Scheme (EU ETS) carbon derivatives provide private sector decision-makers with inconsistent signals and are economically costly. The high volatility observed is not inherent in this kind of instrument, but is rather due to the lack of policy towards the development of an efficient carbon derivatives market and the absence of a standard pricing tool.

Leconte, A. and T. Pagano (2010). "Carbon Derivatives: A Destabilizing or a Virtuous Mechanism to Build a Carbon-Free Economy? The Example of the European CO2 Trading Scheme." USAEE-IAEE Working Paper No. 10-058, available at SSRN, Nov 2010.