The Price of Oil Risk

We solve a Pareto risk-sharing problem with heterogeneous agents with recursive utility over multiple goods. We use this optimal consumption allocation to derive a pricing kernel and the price of oil and related futures contracts. This gives us insight into the dynamics of risk premia in commodity markets for oil. As an example, in a calibrated version of our model we show how rising oil prices and falling oil risk premium are an outcome of the dynamic properties of the optimal risk sharing solution. We also compute portfolios that implement the optimal consumption policies and demonstrate that large and variable open interest is a property of optimal risk sharing. ∗ Thanks to seminar participants at the Carnegie Mellon University, Federal Reserve Board, University of Texas at Austin, and Alberta Finance Institute Conference: Speculation, Risk Premiums, and Financing Conditions in Commodity Markets at the University of Calgary for comments. † Tepper School of Business, Carnegie Mellon University; [email protected]. ‡ Tepper School of Business, Carnegie Mellon University; [email protected].