Family history of diabetes is a major risk factor for type 2 diabetes (T2D), but whether this association derives from shared genetic or environmental factors is unclear. To address this question, we developed a statistical framework that models four components of variance, including known and unknown genetic and environmental factors, using a liability threshold model. Focusing on parental history, we simulated case-control studies with two first-degree relatives for each individual, assuming 50 % genetic similarity and a range of values of environmental similarity. By comparing the association of parental history with T2D in our simulations to case-control studies of T2D nested in the Nurses' Health Study and Health Professionals Follow-up Study, we estimate that first-degree relatives have a correlation of 23 % (95 % CI 15-27 %) in their environmental contribution to T2D liability and that this shared environment is responsible for 32 % (95 % CI 24-36 %) of the association between parental history and T2D, with the remainder due to shared genetics. Estimates are robust to varying model parameter values and our framework can be extended to different definitions of family history. In conclusion, we find that the association between parental history and T2D derives from predominately genetic but also environmental effects.