Optimal Pricing Instruments for Emission Reduction Certificates

Abstract

The Clean Development Mechanism (CDM), launched under the Kyoto Protocol, is intended to internalize environmental externalities and to help developing countries achieve their developmental objectives employing cleaner, albeit possibly more expensive, technologies, inter alia creating markets for trading of emission reduction certificates (“certified emission reduction” CER). Statistical analyses reveal trends in pricing of Euro-denominated CERs, which is interpreted as market inefficiency. Since the exporting countries are required to “liquidate,” “package,” and “export” a natural asset and, in real terms, surrender the option to employ certain technologies or to undertake certain initiatives, they should be recompensed through an asset of comparable quality and, more importantly, one on whose valuation the sellers have sufficient control. A currency basket consisting of major CER exporting country currencies is considered. A specially constructed synthetic currency named the CERO, a weighted average of the CER exporting countries’ import partners’ currencies, is proposed as a second alternative.