Research

This paper examines how climate-related risks are priced in the commodity derivatives market. Leveraging a unique dataset of “brown” and “green” iron ore options traded on the Singapore Exchange, we document significant climate variance and skewness risk premiums. Further analysis reveals a nonlinear relationship between climate policy uncertainty and climate risk premiums: moderate uncertainty increases premiums by destabilizing market expectations, whereas extreme uncertainty suppresses market activity and reduces premiums. Additionally, climate policy uncertainty produces asymmetric effects: sustained levels and changes in uncertainty have a stronger impact than immediate fluctuations in uncertainty. These effects concentrate in short-maturity options, underscoring the transitional nature of policy risks. Utilizing a novel two-stage differencing method, this study provides a direct and robust measure of climate risk premiums, advancing our understanding of climate risk pricing in commodity derivatives markets and offering valuable insights for policymakers seeking to stabilize markets and promote sustainable investment.