Annals of Applied Probability

Singular forward–backward stochastic differential equations and emissions derivatives

René Carmona, François Delarue, Gilles-Edouard Espinosa, and Nizar Touzi

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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 CO${}_{2}$ 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 CO${}_{2}$ option pricing.

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Ann. Appl. Probab., Volume 23, Number 3 (2013), 1086-1128.

First available in Project Euclid: 7 March 2013

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Primary: 60H30: Applications of stochastic analysis (to PDE, etc.) 91G80: Financial applications of other theories (stochastic control, calculus of variations, PDE, SPDE, dynamical systems)

Stochastic analysis forward–backward stochastic differential equations emissions derivatives


Carmona, René; Delarue, François; Espinosa, Gilles-Edouard; Touzi, Nizar. Singular forward–backward stochastic differential equations and emissions derivatives. Ann. Appl. Probab. 23 (2013), no. 3, 1086--1128. doi:10.1214/12-AAP865.

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