Singular forward-backward stochastic differential equations and emissions derivatives

Rene A. Carmona, François Delarue, Gilles Edouard Espinosa, Nizar Touzi

Research output: Contribution to journalArticle

6 Scopus citations

Abstract

We introduce two simple models of forward-backward stochastic differential equations with a singular terminal condition and we explain how and why they appear naturally as models for the valuation of CO2 emission allowances. Single phase cap-and-trade schemes lead readily to terminal conditions given by indicator functions of the forward component, and using fine partial differential equations estimates, we show that the existence theory of these equations, as well as the properties of the candidates for solution, depend strongly upon the characteristics of the forward dynamics. Finally, we give a first order Taylor expansion and show how to numerically calibrate some of these models for the purpose of CO2 option pricing.

Original languageEnglish (US)
Pages (from-to)1086-1128
Number of pages43
JournalAnnals of Applied Probability
Volume23
Issue number3
DOIs
StatePublished - Jun 2013

All Science Journal Classification (ASJC) codes

  • Statistics and Probability
  • Statistics, Probability and Uncertainty

Keywords

  • Emissions derivatives
  • Forward-backward stochastic differential equations
  • Stochastic analysis

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