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Transition Linker Pricing

Malinconico, Gabriel LU and Jakobsson, Thea (2025) In Master's Thesis in Mathematical Sciences FMSM01 20251
Mathematical Statistics
Abstract
As the urgency of addressing climate change intensifies, innovative financial instruments are needed to align capital markets with sustainability goals. This thesis explores the concept of the \textit{transition linker}, a hypothetical performance-linked sovereign bond whose cash flows depend on greenhouse gas emission reduction targets, as outlined in its Nationally Determined Contributions under the Paris Agreement. Transition linkers aim to provide transparent, verifiable incentives for climate action by embedding emissions performance into bond pricing.

Using a stochastic modeling approach, future emission trajectories are simulated with a Geometric Brownian Motion model to estimate the likelihood of meeting emissions targets. These... (More)
As the urgency of addressing climate change intensifies, innovative financial instruments are needed to align capital markets with sustainability goals. This thesis explores the concept of the \textit{transition linker}, a hypothetical performance-linked sovereign bond whose cash flows depend on greenhouse gas emission reduction targets, as outlined in its Nationally Determined Contributions under the Paris Agreement. Transition linkers aim to provide transparent, verifiable incentives for climate action by embedding emissions performance into bond pricing.

Using a stochastic modeling approach, future emission trajectories are simulated with a Geometric Brownian Motion model to estimate the likelihood of meeting emissions targets. These probabilities are then used to derive theoretical fair values for both \textit{premium} and \textit{zero-cost} transition linker structures. A case study involving Germany, France, and Italy demonstrates how differences in emission trends and volatility directly affect pricing outcomes.

The results showed that transition linkers are conceptually straightforward to model and could be practically implemented using existing financial frameworks. However, under certain parameter conditions, particularly for zero-cost linkers, the implied coupon adjustments can become unrealistic. This highlights important design trade-offs and the need for further refinement before real-world application. Overall, the transition linker represents a promising addition to the sustainable finance toolkit, offering a more standardized and data-driven alternative to current sustainability-linked bonds. (Less)
Please use this url to cite or link to this publication:
author
Malinconico, Gabriel LU and Jakobsson, Thea
supervisor
organization
course
FMSM01 20251
year
type
H2 - Master's Degree (Two Years)
subject
keywords
Sustainable finance, Transition linkers, Greenhouse gas emissions, Sustainability-linked bonds, Geometric Brownian Motion
publication/series
Master's Thesis in Mathematical Sciences
report number
LUTFMS-3519-2025
ISSN
1404-6342
other publication id
2025:E42
language
English
id
9193105
date added to LUP
2025-06-09 15:54:15
date last changed
2025-06-09 15:54:15
@misc{9193105,
  abstract     = {{As the urgency of addressing climate change intensifies, innovative financial instruments are needed to align capital markets with sustainability goals. This thesis explores the concept of the \textit{transition linker}, a hypothetical performance-linked sovereign bond whose cash flows depend on greenhouse gas emission reduction targets, as outlined in its Nationally Determined Contributions under the Paris Agreement. Transition linkers aim to provide transparent, verifiable incentives for climate action by embedding emissions performance into bond pricing.

Using a stochastic modeling approach, future emission trajectories are simulated with a Geometric Brownian Motion model to estimate the likelihood of meeting emissions targets. These probabilities are then used to derive theoretical fair values for both \textit{premium} and \textit{zero-cost} transition linker structures. A case study involving Germany, France, and Italy demonstrates how differences in emission trends and volatility directly affect pricing outcomes.

The results showed that transition linkers are conceptually straightforward to model and could be practically implemented using existing financial frameworks. However, under certain parameter conditions, particularly for zero-cost linkers, the implied coupon adjustments can become unrealistic. This highlights important design trade-offs and the need for further refinement before real-world application. Overall, the transition linker represents a promising addition to the sustainable finance toolkit, offering a more standardized and data-driven alternative to current sustainability-linked bonds.}},
  author       = {{Malinconico, Gabriel and Jakobsson, Thea}},
  issn         = {{1404-6342}},
  language     = {{eng}},
  note         = {{Student Paper}},
  series       = {{Master's Thesis in Mathematical Sciences}},
  title        = {{Transition Linker Pricing}},
  year         = {{2025}},
}