Fear Premium

Fear Premium

An increase in prices because of investor nervousness about a future event. For example, the price of contracts on oranges may increase if a hurricane is expected to hit Florida (where oranges are grown). The price may return to normal if the event does not take place (or is not as bad as predicted).
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Risk reversions in the euro-dollar forex option market tell me Planet Forex is unwinding the excessive fear premium embedded in upside US dollar protection strategies.
That's higher than what we envisioned earlier this year," he says, "but it factors in the fear premium that is now reflected in crude oil prices.
The fear premium in oil markets may significantly rise and increase oil prices by 20%, leading to negative growth effects in the US, Europe, Japan, China, India and all other advanced economies and emerging markets that are net oil importers.
Analysts said a fear premium was in place due to ongoing tensions in oil-producing regions of North Africa and the Middle East and the recent death of Al-Qaeda leader Osama bin Laden.
Some economists argue that a fear premium may be factored in the oil price for some time.
All signs point to there being a one-for-one substitution so far in terms of barrels, but even so, that doesn't take into account the market impact from a reduction in the quality of those substituted barrels, as well as a fear premium.
Jeff Brown, managing director of Facts Global Energy in Singapore, said: "There's always a fear premium in pricing.
The fear premium was boosted by the threat of conflict in the Middle East triggering another wave of fund inflows in the futures market.
Also, with ongoing tensions in the Middle East which could be translating to as much as a $20 per barrel fear premium in the price of oil (now over $100 per barrel), operating expenses for property will not be letting up.
The tension between the West and Iran over Tehran's nuclear programme will keep the fear premium on WTI and Brent high through the coming months.
In case of a western embargo, the psychological, fear premium would definitely go up.
And we think that the fear premium in oil prices will come down as the situation in Libya improves.