Risk Premia in Carbon and Energy Futures Markets

We propose an approach to estimate and explain the risk premium in carbon and energy futures markets. First, we develop a parsimonious and robust state space model that allows for a time-varying risk premium and apply it to CO2, oil, and gas futures prices. We find that the risk premia are significantly different from zero, strongly time-varying, and that they differ considerably across markets. The CO2 risk premium is mostly positive whereas the oil and natural gas risk premia tend to fluctuate from positive to negative. Next, we extend the existing literature by explaining the risk premia with several macro-financial variables. We show that interest rate, implied volatility, credit risk, and liquidity are important determinants. Moreover, we provide evidence that announcements regarding the EU emissions trading scheme lower the CO2 risk premium and thereby contribute to more transparency