The Estimation of Risk Premium Implicit in Oil Prices
Futures prices can be seen as a sum of the expected value of the underlying asset price with a risk premium. In order to disentangle those two components of the futures prices, one can try to model the relationship between spot and futures prices, in order to obtain a closed expression for the risk premium, or to use information from spot and option prices to estimate risk aversion functions. Given the high volatility of the ratios between futures and spot prices, we opted for the latter, estimating risk-neutral and subjective probability density functions, respectively from option and spot prices observed. Looking at the prices of Brent and West Texas Intermediate Light/Sweet Crude Oil options, evidence obtained suggests that the risk premium is typically very low for levels near the futures prices.
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