A Rational Expectations Model of Time Varying Risk Premia in Commodities Futures Markets: Theory and Evidence

The intertemporal hedging theory is used to model the role of spot price risk, measured by the variance, in futures market risk premia. The model gives a theoretical basis for treating the variance as serially correlated when commodities are storable. T he rational expectations hypothesis implies that agents use the varianc e process to predict risk; therefore, the expected variance should be incorporated in equilibrium risk premia. Tests on data from four commodity markets show that variances do have predictable components ; however, premia are related to expected variances in only one market.