Ilaria Stefani

Università degli Studi di Parma

Title

A new model for the perceived time to transition to a low carbon economy

Authors

Ilaria Stefani

Abstract

In the context of the transition to a low or zero carbon economy, we expect the difference in greenium between pairs of twin bonds with different maturities to disappear or, at least, to reduce in both level and volatility. Consequently, we need a model that imposes a terminal condition on the dynamics of the process representing the difference in nodes within the greenium term structure. An important feature of this difference, observed in empirical data, is its mean-reverting behavior. This characteristic motivates the introduction of ad-hoc models that consider the possibility of a transition occurring at a specific time. We discuss two models: the first is an extension of the classical Vasicek model, where the volatility term remains constant until a future time instant, after which it decreases linearly. This model is integrated into a regime-switching framework, where the perceived deadline for transitioning to a low or zero carbon economy defines the regime. Both models are calibrated using market data extracted from twin German government bonds.