a dynamic analysis of the marketable permits approach to global warming policy a comparison of spatial and temporal flexibility abstract this paper presents a generalized dynamic model of greenhouse gas emissions trading under constraints on the volume of transactions an empirical version of the model is used to evaluate potentially cost saving flexibility mechanisms joint implementation and clean development mechanism and potentially cost adding restrictions supplementarity of the kyoto protocol the results indicate the greatest gains would stem from extending permit trading spatially among industrialized nations although sizable gains would also emanate from the inclusion of developing countries gains from intertemporal trading banking and borrowing are meager restrictions on the volume of permit purchases have by far the most costly effect when developing countries are incorporated into trading sensitivity tests with respect to differential discount rates across countries and technological change indicate the results are robust

bankable permits for the control of environmental pollution abstract intertemporal trading of emission permits banking is often identified as one of three promising market mechanisms for controlling pollution along with averaging and trading surprisingly the efficiency properties of permit banking systems have not been investigated using a simple optimal control model this paper investigates firms incentives for banking or borrowing emission permits and compares the emission and output streams firms would choose with the socially optimal solution we find that in many cases firms will suboptimally choose excessive damage and output levels in early periods and correspondingly too few in later periods if given the opportunity to freely move emissions between time periods we propose a simple alternative trading scheme we term modified banking that counters this problem and should be no more difficult for an environmental authority to implement than a straigth banking system

dynamic asset allocation with event risk major events often trigger abrupt changes in stock prices and volatility we study the implications of jumps in prices and volatility on investment strategies using the event risk framework of duffie pan and singleton 2000 we provide analytical solutions to the optimal portfolio problem event risk dramatically affects the optimal strategy an investor facing event risk is less willing to take leveraged or short positions the investor acts as if some portion of his wealth may become illiquid and the optimal strategy blends both dynamic and buy and hold strategies jumps in prices and volatility both have important effects

robust monetary rules under unstructured model uncertainty abstract this paper revisits a widely adopted approach to robust decision making developed by hansen and sargent 2003 hansen and sargent 2008 henceforth hs and applies it to monetary policy design in the face of model uncertainty we pay particular attention to two issues first we distinguish three possible forms of the implied game between malign nature and the policymaker in the hs procedure each leading to a different robust and approximating equilibria second we impose the zero lower bound zlb constraint on the nominal interest rate we show that the zlb constraint has serious consequences for a policymaker pursuing hs type robustness especially when accompanied by an inability to commit

price and network dynamics in the european carbon market this paper presents an analysis of the european emission trading system as a transaction network it is shown that given the lack of a centralized market place industrial actors had to resort to local connections and financial intermediaries to participate in the market this gave rise to a hierarchical structure in the transaction network to empirically relate networks statistics to market outcomes a pls pm modeling technique is introduced it is shown that the asymmetries in the network induced market inefficiencies e g increased bid ask spread albeit the efficiency of the market has improved from the beginning of phase ii the asymmetry persists imposing unnecessary additional costs on agents and reducing the effectiveness of the market as a mitigation instrument

optimal constrained interest rate rules we show that if policymakers compute the optimal unconstrained interest rate rule within a taylor type class they may be led to rules that generate indeterminacy and or instability under learning this problem is compounded by uncertainty about structural parameters since an optimal rule that is determinate and stable under learning for one calibration may be indeterminate or unstable under learning under a different calibration we advocate a procedure in which policymakers restrict attention to rules constrained to lie in the determinate learnable region for all plausible calibrations and that minimize the expected loss computed using structural parameter priors subject to this constraint

jump processes in natural gas markets abstract many analysts believe that natural gas will have an increasingly important role in the next few decades accordingly understanding the underpinnings of natural gas prices is likely to be critical both to policy analysts and to market participants at present it is common to assume that these prices follow a geometric brownian motion i e that log returns the inter temporal differences in the natural log of prices are normally distributed possibly allowing for some form of mean reversion increasingly however it has been recognized that the arrival of new information can lead to unexpectedly rapid changes or jumps in spot prices the implication is that the presumption of normally distributed log returns may be suspect in particular the prospect for abnormally fat tails becomes important this article investigates the potential presence of jumps in two key natural gas prices the spot price at the henry hub in the u s and the spot price for natural gas at the national balancing point in the u k we found compelling empirical evidence for the importance of jumps in both markets though jumps appear to be more important in the u k

testing for indeterminacy an application to u s monetary policy reply this paper considers a prototypical new keynesian model in which the equilibrium is undetermined if monetary policy is passive the likelihood based estimation of dynamic equilibrium models is extended to allow for indeterminacies and sunspot fluctuations we construct posterior weights for the determinacy and indeterminacy region of the parameter space and estimates for the propagation of fundamental and sunspot shocks according to the estimated model u s monetary policy post 1982 is consistent with determinacy whereas the pre volcker policy is not we find that before 1979 indeterminacy substantially altered the propagation of shocks

monetary policy and stagflation in the uk the volatile behavior of inflation output and interest rates in the united kingdom prior to the 1990s helps discriminate between rival explanations for the outbreak of stagflation we examine alternative hypotheses with a new keynesian model of aggregate demand and inflation determination estimated on quarterly uk data for 1959 2000 our model features is and phillips curves based on optimizing behavior and fully incorporates the distinction between detrended output and the output gap stressed by optimizing analysis using simulations of our model as well as information on the real time views of policymakers we test alternative explanations for the outbreak of inflation in the united kingdom in the 1960s and 1970s we find that inaccurate estimates of the degree of excess demand in the economy contributed significantly to the outbreak but we also find a major role for the failure at the time to recognize the importance of monetary policy as opposed to nonmonetary devices in controlling inflation

real investment options with multiple sources of rare events abstract we value real investment options when the underlying asset follows a mixed jump diffusion process involving various types sources of rare events jumps these jumps are assumed independent of each other with each type having a log normally distributed jump size and a random poisson distributed arrival time they may represent uncertainties about the arrival and impact on the underlying investment of new information concerning technological innovation competition political risk regulatory effects and other sources an analytic solution is presented for european claims call or put options with multiple sources of jumps a discrete time markov chain methodology implemented within a finite difference scheme is proposed for the valuation of american as well as european options the approach is also applicable to financial options with multiple types of rare events the approach is illustrated through valuing complex real options with compound features involving interactions between optimal investment and subsequent operating decisions specifically we value a growth option and an extension option

geometric brownian motion and structural breaks in oil prices a quantitative analysis the purpose of this paper is to present a quantitative analyses of oil price s path we try to argue that despite its parsimony and simplicity geometric brownian motion can perform well as a proxy for the movement of oil prices and for a state variable to evaluate oil deposits we base our argument on evidences of very low speed of mean reverting or long half life since unit root tests only can reject its null hypothesis in a sample longer than 100 years on the other hand we reject the null hypothesis of unit root with two endogenous breaks showing that the usual rejection can be attributed to omitted structural breaks we conclude that the average half life of oil price between 4 and 8 years depending on the model chosen is long enough to allow a good approximation as a geometric brownian motion

an econometric analysis of emission allowance prices knowledge of the statistical distribution of the prices of emission allowances and their forecastability are crucial in constructing among other things purchasing and risk management strategies in the emissions constrained markets this paper analyzes the two emission permits markets co2 in europe and so2 in the us and investigates a model for dealing with the unique stylized facts of this type of data its effectiveness in terms of model fit and out of sample value at risk forecasting as compared to models commonly used in risk forecasting contexts is demonstrated

low inflation pass through and the pricing power of firms abstract recently there has been a significant decline in the degree to which firms pass through changes in costs to prices a decline that is frequently characterized as a reduction in the pricing power of firms the decline appears to be associated with the decline in inflation in many countries the decline has important implications for monetary policy because it affects both forecasts of inflation and the effects of changes in monetary policy on inflation some have argued that the decline in pricing power helped to keep inflation low in the face of apparently strong demand pressures in the united states in the late 1990s this paper puts forth the view that the decline in pass through or pricing power is due to the low inflation environment that has recently been achieved in many countries first a microeconomic model of price setting is used to show that lower pass through is caused by lower perceived persistence of cost changes evidence is then presented showing that inflation is positively correlated with persistence of inflation suggesting that the low inflation itself has caused the low pass through an economy wide model consistent with the micromodel is then presented to illustrate how such changes in pricing power affect output and inflation dynamics in favorable ways but can disappear quickly if monetary policy and expectations change

habit formation in consumption and its implications for monetary policy models this paper explores a monetary policy model with habit formation for consumers in which consumers utility depends in part on current consumption relative to past consumption the empirical tests developed in the paper show that one can reject the hypothesis of no habit formation with tremendous condence largely because the habit formation model captures the gradual hump shaped response of real spending to various shocks the paper then embeds the habit consumption specication in a monetary policy model and nds that the responses of both spending and inflation to monetary policy actions are signicantly improved by this modication jel d12 e52 e43

worldwide macroeconomic stability and monetary policy rules we study the interaction of multiple large economies in dynamic stochastic general equilibrium each economy has a monetary policymaker that attempts to control the economy through the use of a linear nominal interest rate feedback rule we show how the determinacy of worldwide equilibrium depends on the joint behavior of policymakers worldwide we also show how indeterminacy exposes all economies to endogenous volatility even ones where monetary policy may be judged appropriate from a closed economy perspective we construct and discuss two quantitative cases in the 1970s worldwide equilibrium was characterized by a two dimensional indeterminacy despite u s adherence to a version of the taylor principle in the last 15 years worldwide equilibrium was still characterized by a one dimensional indeterminacy leaving all economies exposed to endogenous volatility our analysis provides a rationale for a type of international policy coordination and the gains to coordination in the sense of avoiding indeterminacy may be large

on the stochastic properties of carbon futures prices pricing carbon is a central concern in environmental economics due to the worldwide importance of emissions trading schemes to regulate pollution this paper documents the presence of small and large jumps in the stochastic process of the co 2 futures price the large jumps have a discrete origin i e they can arise from various demand factors or institutional decisions on the tradable permits market contrary to the existing literature we show that the stochastic process of carbon futures prices does not contain a continuous component brownian motion the results are derived by using high frequency data in the activity signature function framework todorov and tauchen in j econom 154 125 138 2010 todorov and tauchen in j bus econ stat 29 356 371 2011 the implication is that the carbon futures price should be modeled as an appropriately sampled centered levy or poisson process the pure jump behavior of the carbon price might be explained by the lower volume of trades on this allowance market compared to other highly liquid financial markets

short term variations and long term dynamics in commodity prices in this article we develop a two factor model of commodity prices that allows meanreversion in short term prices and uncertainty in the equilibrium level to which prices revert although these two factors are not directly observable they may be estimated from spot and futures prices intuitively movements in prices for long maturity futures contracts provide information about the equilibrium price level and differences between the prices for the short and long term contracts provide information about short term variations in prices we show that although this model does not explicitly consider changes in convenience yields over time this short term long term model is equivalent to the stochastic convenience yield model developed in gibson and schwartz 1990 we estimate the parameters of the model using prices for oil futures contracts and apply the model to some hypothetical oil linked assets to demonstrate its use and some of its advantages over the gibson schwartz model

the economics of pollution permit banking in the context of title iv of the 1990 clean air act amendments abstract this paper presents a model of the collective emission permit banking behavior of electricity generating units affected by title iv of the clean air act amendments of 1990 a rigorous treatment of the constraint that pollution permits cannot be borrowed from future allocations is introduced this approach enables an analysis of the impact of future changes in electricity demand regulations and technologies on the present permit price and emissions level the effect of uncertainty on the banking behavior is also explored

robust monetary policy in a small open economy abstract we study how a central bank in a small open economy should conduct monetary policy if it fears that its model is misspecified using a new keynesian model of a small open economy we solve analytically for the optimal robust policy rule and the equilibrium dynamics and we separately analyze the consequences of central bank robustness against misspecification concerning the determination of inflation output and the exchange rate we show that an increase in the preference for robustness makes the central bank respond more aggressively or more cautiously to shocks depending on the type of shock and the source of misspecification

a note on tradeable permits this note offers a perspective on whether tradeable permits are a passing fad or an enduring trend it does so in noting how various types of tradeable permit systems relate to conventional environmental permits what are the unique requirements of tradeable permit systems and why they might be preferred to alternative instruments a final observation concerns the analogy between tradeable permits for environmental goods and private property in land

how forward looking is the fed direct estimates from a calvo type rule we estimate an alternative type of monetary policy rule according to which the central bank targets a discounted infinite sum of expected inflation and output gaps empirical results suggest that the fed has a mean forward horizon of 4 to 8 quarters

modeling co2 emission allowance prices and derivatives evidence from the european trading scheme this paper studies the three main markets for emission allowances within the european union emissions trading scheme eu ets powernext nord pool and european climate exchange ecx the analysis suggests that the prohibition of banking of emission allowances between distinct phases of the eu ets has significant implications in terms of futures pricing motivated by these findings we develop an empirically and theoretically valid framework for the pricing and hedging of intra phase and inter phase futures and options on futures respectively

inflation forecasts and monetary policy proposals for inflation targeting as a strategy for monetary policy leave open the important operational question of how to determine whether current policies are consistent with the long run inflation target an interesting possibility is that the central bank might target current private sector forecasts of inflation either those made explicitly by professional forecasters or those implicit in asset prices we address the issue of existence and uniqueness of rational expectations equilibria when the central bank uses private sector forecasts as a guide to policy actions in a dynamic model which incorporates both sluggish price adjustment and shocks to aggregate demand and aggregate supply we show that strict targeting of inflation forecasts is typically inconsistent with the existence of rational expectations equilibrium and that policies approximating strict inflation forecast targeting are likely to have undesirable properties we also show that economies with more general forecast based policy rules are particularly susceptible to indeterminacy of rational expectations equilibria we conclude that although private sector forecasts may contain information useful to the central bank ultimately the monetary authorities must rely on an explicit structural model of the economy to guide their policy decisions this abstract was borrowed from another version of this item this abstract was borrowed from another version of this item

intertemporal permit trading for the control of greenhouse gas emissions this paper integrates two themes in the intertemporal permitliterature through the construction of an intertemporal bankingsystem for a pollutant that creates both stock and flow damages a permit banking system for the special case of a pollutant thatonly causes stock damages is also developed this latter simpler case corresponds roughly to the greenhouse gas emissionreduction regime proposed by the u s department of state as ameans of fulfilling the u s commitment to the frameworkconvention on climate change this paper shows that environmentalregulators can achieve the socially optimal level of emissionsand output through time by setting the correct total sum ofallowable emissions and specifying the correct intertemporaltrading ratio for banking and borrowing for the case ofgreenhouse gases we show that the optimal growth rate of permitprices and therefore the optimal intertemporal trading rate hasthe closed form solution equal to the ratio of current marginalstock damages to the discounted future value of marginal stockdamages less the decay rate of emissions in the atmosphere given a non optimal negotiated emission path we then derive apermit banking system that has the potential to lower net socialcosts by adjusting the intertemporal trading ratio taking intoaccount the behavior of private agents we use a simplenumerical simulation model to illustrate the potential gains fromvarious possible banking systems

a model of intertemporal emission trading banking and borrowing abstract this paper provides a general treatment of emission trading banking and borrowing in an intertemporal continuous time model using optimal control theory the decentralized behavior of firms is shown to lead to the least cost solution attainable under joint cost minimization explicit solutions for the time paths of emissions and permit prices are derived when firms are allowed to both bank and borrow and when firms are only allowed to bank emission permits the policy implications of emission banking and borrowing are discussed

valuation of commodity futures and options under stochastic convenience yields interest rates and jump diffusions in the spot this paper investigates the effects of stochastic convenience yields stochastic interest rates and jumps in the spot price on the pricing of commodity futures forwards and futures options numerical examples show that one factor prices differ materially from the stochastic convenience yield two factor prices when convenience yield is considerably above its long term average the extension to a three factor model with stochastic interest rates leads to a different futures price but the forward price is unchanged the extension ofthe three factor model to include jumps in the spot price process does not affect forward or futures prices but it can have an impact on options prices the model is applied to price the present value of future cash flows from a real asset

modeling the price dynamics of co2 emission allowances abstract in this paper we analyze the short term spot price behavior of carbon dioxide co 2 emission allowances of the new eu wide co 2 emissions trading system eu ets after reviewing the stylized facts of this new class of assets we investigate several approaches for modeling the returns of emission allowances due to different phases of price and volatility behavior in the returns we suggest the use of markov switching and ar garch models for stochastic modeling we examine the approaches by conducting an in sample and out of sample forecasting analysis and by comparing the results to alternative approaches our findings strongly support the adequacy of the models capturing characteristics like skewness excess kurtosis and in particular different phases of volatility behavior in the returns

does the reserve bank of australia follow a forward looking nonlinear monetary policy rule abstractthe conventional monetary policy rule describes a simple linear relationship between the domestic interest rate inflation rate and output gap an important extension to this rule is to inc

the fine structure of asset returns an empirical investigation we investigate the importance of diffusion and jumps in a new model for asset returns in contrast to standard models we allow for jump components displaying finite or infinite activity and variation empirical investigations of time series indicate that index dynamics are devoid of a diffusion component which may be present in the dynamics of individual stocks this leads to the conjecture confirmed on options data that the risk neutral process should be free of a diffusion component we conclude that the statistical and risk neutral processes for equity prices are pure jump processes of infinite activity and finite variation

dynamic income progressive taxes and the timing of charitable contributions using an econometric model of charitable giving and a 10 year panel of tax return data i find that previous studies have underestimated the effects of permanent income and overestimated the effects of permanent changes in tax prices the significant statutory tax changes that occurred during the 1980s especially in 1986 serve to identify the key model parameters my results imply that people smooth their giving when transitory income changes but also time their giving to exploit transitory changes in tax prices the results also raise questions about how effectively the tax incentives permanently influence the level rather than just the timing of charitable giving by individuals

robust inflation forecast based rules to shield against indeterminacy abstract this paper provides a first attempt to quantify and at the same time utilize estimated measures of uncertainty for the design of robust interest rate rules we estimate several variants of a linearized form of a new keynesian model using quarterly us data both our theoretical and numerical results indicate that inflation forecast based ifb rules are increasingly prone to the problem of indeterminacy as the forward horizon increases as a consequence the stabilization performance of optimized rules of this type worsens too robust ifb rules can be designed to avoid indeterminacy in an uncertain environment but at an increasing utility loss as rules become more forward looking

a model of carbon price interactions with macroeconomic and energy dynamics abstract this paper develops a model of carbon pricing by considering two fundamental drivers of european union allowances economic activity and energy prices on the one hand economic activity is proxied by aggregated industrial production in the eu 27 as it provides the best performance in a preliminary forecasting exercise vs other indicators on the other hand brent natural gas and coal prices are selected as being the main carbon price drivers as highlighted by previous literature the interactions between the macroeconomic and energy spheres are captured in a markov switching var model with two states that is able to reproduce the boom bust business cycle hamilton 1989 first industrial production is found to impact positively negatively the carbon market during periods of economic expansion recession thereby confirming the existence of a link between the macroeconomy and the price of carbon second the brent price is confirmed to be the leader in price formation among energy markets bachmeier and griffin 2006 as it impacts other variables through the structure of the markov switching model taken together these results uncover new interactions between the recently created eu emissions market and the pre existing macroeconomic energy environment

trader types and volatility of emission allowance prices evidence from eu ets phase i abstract this paper studies the relation between the trading activity of market participants and the volatility of the european emission allowance price during phase i of the european union emission trading system eu ets we focus on the contrasting roles of different trader types we find evidence of a positive and significant trading activity volatility relation which appears to be stronger when accounting for trader type the positive relation can be mainly attributed to energy providers in contrast industrial companies seem to have traded more frequently when volatility levels were lower finally the non liable players represented by financial intermediaries appear to have acted as a flexible counterparty trading more with the energy sector when volatility was higher and more with the industrial firms when volatility was lower we discuss possible explanations for these contrasted positions understanding the trading activity volatility link is relevant for evaluating the efficiency of the eu ets although the relation is generally positive many players remained often inactive and traded mostly when volatility levels were lower policies targeting the engagement of less active players could lead to a smoother incorporation of information into prices and to an increase in market efficiency

bounded interest rate feedback rules in continuous time this paper analyzes the dynamic consequences of interest rate feedback rules in a flexible price model where money enters the utility function two alternative rules are considered based on past or predicted inflation rates the main feature is to consider inflation rates that are selected over a bounded time horizon we prove that if the central bank s forecast horizon is not too long an active and forward looking monetary policy is not destabilizing the equilibrium trajectory is unique and monotonic this is an advantage with respect to active and backward looking policies that are shown to lead to a unique but fluctuating dynamic

risk neutral models for emission allowance prices and option valuation the existence of mandatory emission trading schemes in europe and the united states and the increased liquidity of trading on futures contracts on co2 emissions allowances led naturally to the next step in the development of these markets these futures contracts are now used as underliers for a vibrant derivative market in this paper we give a rigorous analysis of a simple risk neutral reduced form model for allowance futures prices demonstrate its calibration to historical data and show how to price european call options written on these contracts this paper was accepted by haitao li guest editor finance

how robustness can lower the cost of discretion model uncertainty has the potential to change importantly how monetary policy is conducted making it an issue that central banks cannot ignore using a standard new keynesian business cycle model this paper analyzes the behavior of a central bank that conducts policy under discretion while fearing that its model is misspecified the main results are as follows first policy performance can be improved if the discretionary central bank implements a robust policy this important result is obtained because the central bank s desire for robustness directs it to assertively stabilize inflation thereby mitigating the stabilization bias associated with discretionary policymaking second the central bank s fear of model misspecification leads it to forecast future outcomes under the belief that inflation in particular will be persistent and have large unconditional variance raising the probability of extreme outcomes private agents however anticipating the policy response make decisions under the belief that inflation will be more closely stabilized that is more tightly distributed than under rational expectations finally as a technical contribution the paper shows how to solve with robustness an important class of linear quadratic decision problems

oil price hikes and development triggers in peace and war the theory of irreversible investment predicts that development of an oil field should take place when a unique price trigger is passed at the start of the 1990 91 gulf war however oil prices promptly doubled only to fall back to their previous level when peace returned six months later to incorporate such large but transitory price hikes we evaluate the profitability of an oil field contingent on war and peace and calculate separate triggers in each case for plausible parameter values we find that the switch between these development triggers is about 45 of the price hike caused by the war the price hike is therefore equivalent to a permanent price increase of only a quarter of its size copyright 1996 by royal economic society

habit formation in consumption a meta analysis abstract we examine 597 estimates of habit formation reported in 81 published studies the mean reported strength of habit formation equals 0 4 but the estimates vary widely both within and across studies we use bayesian and frequentist model averaging to assign a pattern to this variance while taking into account model uncertainty studies employing macro data report consistently larger estimates than micro studies 0 6 vs 0 1 on average the difference remains 0 5 when we control for 30 factors that reflect the context in which researchers obtain their estimates such as data frequency geographical coverage variable definition estimation approach and publication characteristics we also find that evidence for habits strengthens when researchers use lower data frequencies employ log linear approximation of the euler equation and utilize open economy dsge models moreover estimates of habits differ systematically across countries

the performance of forecast based monetary policy rules under model uncertainty we investigate the performance of forecast based monetary policy rules using five macroeconomic models that reflect a wide range of views on aggregate dynamics we identify the key characteristics of rules that are robust to model uncertainty such rules respond to the one year ahead inflation forecast and to the current output gap and incorporate a substantial degree of policy inertia in contrast rules with longer forecast horizons are less robust and are prone to generating indeterminacy in light of these results we identify a robust benchmark rule that performs very well in all five models over a wide range of policy preferences

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 co2 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