Market-implied time to transition to a low-carbon economy: a stochastic modelling and inference framework

TL;DR

This paper proposes a novel market-implied measure called Time to Transition (TtT), derived from greenium term structures, and develops stochastic models and inference methods to estimate transition timing to a low-carbon economy.

Contribution

It introduces the TtT concept and two tractable stochastic frameworks for modeling transition timing, along with inference techniques for monitoring and estimating transition dates.

Findings

TtT is derived from greenium differences across maturities.

Two stochastic models enable inference of transition timing.

Framework allows operational monitoring and structural parameter estimation.

Abstract

This paper introduces a new market-implied object, Time to Transition (TtT), extracted from the difference between two selected nodes of the greenium term structure. TtT is defined as the latent waiting time until this cross-maturity greenium difference vanishes, meaning that the greenium becomes equal across the two selected maturities. We develop an inference theory for this object. To model TtT, we introduce two tractable stochastic frameworks: the Regulatory Deadline-Constrained Model, in which the transition date is fixed, and a switching extension, in which alternative transition dates capture heterogeneous perceived deadlines across economic agents. The paper combines two layers of analysis. On a fixed daily grid, a deadline-constrained diffusion provides a tractable benchmark through an exact Gaussian bridge likelihood, while the switching extension preserves tractability through regime-specific bridge densities and filtering recursions. Under a fixed-horizon infill scheme, the same framework yields a structural identification result for the regime-wise diffusion parameters, with full or partial consistency depending on the observed region. The paper therefore contributes both a new inferential object, market-implied transition timing based on cross-maturity differences in the greenium term structure, and a two-layer inference framework: finite-sample filtering provides an operational monitoring tool, while fixed-horizon infill asymptotics specify when the regime-wise diffusion parameters carrying information about competing transition dates can be consistently estimated.