Pricing Mechanisms and Development Prospects of Green Financial Derivatives

Abstract

Nowadays, green finance has become a significant way to guide the direction of investment because of the growing global climate pressures like the aggravation of greenhouse effect and the urgent need for the low-carbon transition. Therefore, tools like green bonds and green loans are widely used. For example, China’s green credit balance was over 35.75 trillion CNY by the third quarter of 2024. However, green financial derivatives are not well developed, such as green bond futures, carbon-linked options, especially in emerging economies. This paper put forward an improved pricing framework which uses an ESG-GARCH model to put ESG risk indicators and climate data together, in order to track the dynamic impact of volatility. This paper also uses a vector automatic progress (VAR) model to analyze the connections between green fusion variables. The study uses data from futures in the EU emissions trading system, risks and climate value of the green index. Analysis shows that policy uncertainty, environmental externalities and cash liquidity fluctuations caused by ESG factors are core issues in pricing. The study ultimately provides practical advice to businesses, financial institutions and policy makers to enhance market development and point out future research directions to improve the accuracy of models and market credibility. This study aims to connect theory and practice and improve the financial system’s ability to manage climate risks and expand sustainable investment.