Risk Premia in Crude Oil Futures Prices

Abstract

If commercial producers or financial investors use futures contracts to hedge against commodity price risk, the arbitrageurs who take the other side of the contracts may receive compensation for their assumption of non-diversifiable risk in the form of positive expected returns from their positions. We show that this interaction can produce an affine factor structure to commodity futures prices, and develop new algorithms for estimation of such models using unbalanced data sets in which the duration of observed contracts changes with each observation. We document significant changes in oil futures risk premia since 2005, with the compensation to the long position smaller on average but more volatile in more recent data. This observation is consistent with the claim that index-fund investing has become more important relative to commercial hedging in determining the structure of crude oil futures risk premia over time.