World Federation of Exchanges research quantifies climate risk premium in commodity options and links it to climate policy uncertainty

The World Federation of Exchanges published research finding that climate risks are positively priced into commodity options, creating a climate risk premium that rewards investors for bearing climate-related risk. It also identifies a non-linear relationship between climate policy uncertainty and the size of that premium. The paper analyses a proprietary dataset of two iron ore option contracts traded on the Singapore Exchange, one classified as “brown” and the other as “green”, and uses a two-stage differencing methodology to isolate climate risk premia without relying on ESG ratings or event studies. Moderate levels of climate policy uncertainty are associated with higher climate risk premia, while extreme uncertainty beyond a certain level is associated with lower premia as traders and producers adopt a “wait and see” approach; the study also points to climate-focused commodity option derivatives as a tool for managing climate risk exposure and argues that transparent and predictable climate policies can reduce uncertainty and support more efficient pricing.