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We present a novel approach to the pricing of financial instruments inemission markets, for example, the EU ETS. The proposed structural model ispositioned between existing complex full equilibrium models and pure reducedform models. Using an exogenously specified demand for a polluting good itgives a causal explanation for the accumulation of CO2 emissions and takes intoaccount the feedback effect from the cost of carbon to the rate at which themarket emits CO2. We derive a forward-backward stochastic differential equationfor the price process of the allowance certificate and solve the associatedsemilinear partial differential equation numerically. We also show thatderivatives written on the allowance certificate satisfy a linear partialdifferential equation. The model is extended to emission markets with multiplecompliance periods and we analyse the impact different intertemporal connectingmechanisms, such as borrowing, banking and withdrawal, have on the allowanceprice.

Risk-Neutral Pricing of Financial Instruments in Emission Markets: A Structural Approach