New WFE Research Discovers Climate Risk Premium in Commodity Options

 

PRESS RELEASE

New WFE Research Discovers Climate Risk Premium in Commodity Options

London, 13th May 2025 – The World Federation of Exchanges’ (WFE) new research finds that climate risks are positively priced into commodity options - meaning investors are rewarded for the climate-related risk they bear in holding these assets.

The research also highlights a relationship between climate policy uncertainty and climate risk premiums: moderate levels of policy uncertainty increase climate risk premiums by unsettling market expectations, while extreme uncertainty, beyond a certain level, reduces climate risks premiums as traders and producers adopt a “wait and see” strategy.

The paper, “Climate Risk Premium: Evidence from Commodity Options”, authored by Kaitao Lin, Xin Gao, Bingxin Li, and Rui Liu, is the first to document and quantify the existence of a climate risk premium using commodity options. 

The WFE’s research analysed a proprietary dataset featuring two iron ore option contracts: one classified as “brown” and the other as “green”, but both traded on the Singapore Exchange (SGX). Using an innovative two-stage differencing methodology to isolate the climate risk premium without relying on subjective ESG ratings or event studies, the research was able to compare risk premiums between two nearly identical option contracts which differed only in their environmental impact.

The paper’s findings carry critical implications for investors, government, climate professionals and policymakers. By demonstrating climate-focused commodity option derivatives as a useful tool for managing exposure to climate risk, the research proves that transparent and predictable climate policies can stabilise markets and reduce uncertainty. 

Nandini Sukumar, CEO of the WFE, said, “Climate policy uncertainty affects risk premiums. Our findings show that clearer and more predictable policy guidelines can help stabilise markets. Such transparency and consistency in environmental regulations can reduce uncertainty, facilitate more efficient climate risk pricing, and encourage greater investment in sustainable assets, thereby contributing to broader climate-change mitigation objectives.”

Dr Pedro Gurrola-Perez, Head of Research at the WFE, said, “Looking at commodity derivatives is particularly interesting as some of these financial instruments are directly tied to products with diverse environmental impact. WFE Research looks forward to studying key areas in market design and infrastructure as the world seeks to limit, mitigate and reverse the impact of climate change.”

Read the full paper here.

For more information, please contact:

Cally Billimore                

Communications Manager        

[email protected]

+44 7391 204 007

About the World Federation of Exchanges (WFE):

Established in 1961, the WFE is the global industry association for exchanges and clearing houses. Headquartered in London, it represents over 250 market infrastructure providers, including standalone CCPs that are not part of exchange groups. Of our members, 37% are in Asia-Pacific, 43% in EMEA and 20% in the Americas. WFE’s 87 member CCPs and clearing services collectively ensure that risk takers post some $1.1 trillion (equivalent) of resources to back their positions, in the form of initial margin and default fund requirements. WFE exchanges, together with other exchanges feeding into our database, are home to over 49,054 listed companies, and the market capitalisation of these entities is $116.58 trillion; around $155 trillion (EOB) in trading annually passes through WFE members (at end 2024). 

The WFE is the definitive source for exchange-traded statistics and publishes over 350 market data indicators. Its free statistics database stretches back more than 40 years and provides information and insight into developments on global exchanges. The WFE works with standard-setters, policy makers, regulators and government organisations around the world to support and promote the development of fair, transparent, stable and efficient markets. The WFE shares regulatory authorities’ goals of ensuring the safety and soundness of the global financial system. 

With extensive experience of developing and enforcing high standards of conduct, the WFE and its members support an orderly, secure, fair and transparent environment for investors; for companies that raise capital; and for all who deal with financial risk. We seek outcomes that maximise the common good, consumer confidence and economic growth. And we engage with policy makers and regulators in an open, collaborative way, reflecting the central, public role that exchanges and CCPs play in a globally integrated financial system. 

Website: www.world-exchanges.org

Twitter: @TheWFE

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