Jan 23, 2013

Variance Risk Premia in Commodity Markets

There is a lot of research on Variance Risk Premium in equity options, but not a lot about commodities. Which is why I wanted to share an interesting research paper on SSRN - Variance Risk Premia in Commodity Markets, which provides thorough analysis of 21 commodities in 6 categories:

Energy: Crude Oil, Heating Oil, Natural Gas
Grains: Corn, Cotton, Soybeans, Soybean Meal, Soybean Oil, Sugar, Wheat
Livestock: Lean Hogs, Live Cattle
Metals: Copper, Gold, Silver
Tropical: Cocoa, Colombian Coffee, Oats, Orange Juice, Rough Rice
Wood: Lumber

They present statistical findings, as well as forecasting model for VRP based on basis and open interest. I have blogged about VRP of VIX options here. Another excellent overview of the topic is Jared Woodard's ebook Options and the Volatility Risk Premium.


  1. Anonymous1/24/2013

    I read somewhere that the term "volatility risk premium" should be beter replaced by "correlation risk premium", because such a premium only exists in index options and not in equity options.

    The correlation of stocks on downward movements explains the reason for such a premium.

    Any comments on that?

  2. Well - commodities don't have correlation and have var risk premium. I don't think it would be correct to exclude var over correlation: index options just happen to have 2 components - var and correlation. But of course all these things are abstract - other people may describe them as liquidity protection, or margin hedging, etc...

  3. Anonymous1/24/2013

    Sinclair wrote an article about the variance premium in a magazine: