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The pricing of degree-day weather options

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  • Calum G. Turvey
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    Abstract

    This paper presents a model and framework for pricing degree-day weather derivatives when the weather variable is a non-traded asset. Using daily weather data from 1840S1996, it is shown that a degree-day weather index exhibits stable volatility and satisfies the random walk hypothesis. The options prices from the recommended model are compared to a typical insurance-type model. The results show that the insurance model overprices the option value at-the-money, and this may explain why the bid-ask spread in the weather derivatives market is sometimes very large.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Agricultural Finance Review.

    Volume (Year): 65 (2005)
    Issue (Month): 1 (May)
    Pages: 59-85

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    Handle: RePEc:eme:afrpps:v:65:y:2005:i:1:p:59-85

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    Related research

    Keywords: Degree-day options; Weather derivatives; Weather risk;

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    Cited by:
    1. Rong Kong & Calum G. Turvey & Guangwen He & Jiujie Ma & Patrick Meagher, 2011. "Factors influencing Shaanxi and Gansu farmers' willingness to purchase weather insurance," China Agricultural Economic Review, Emerald Group Publishing, vol. 3(4), pages 423-440, November.
    2. repec:ags:nc2006:133091 is not listed on IDEAS
    3. Leif Erec Heimfarth & Oliver Musshoff, 2011. "Weather index-based insurances for farmers in the North China Plain: An analysis of risk reduction potential and basis risk," Agricultural Finance Review, Emerald Group Publishing, vol. 71(2), pages 218-239, July.
    4. Markus Stowasser, 2011. "Modelling rain risk: a multi-order Markov chain model approach," Journal of Risk Finance, Emerald Group Publishing, vol. 13(1), pages 45-60, January.
    5. Hotopp, Henning & Mußhoff, Oliver, 2012. "Can rent adjustment clauses reduce the income risk of farms?," International Journal of Agricultural Management, Institute of Agricultural Management;International Farm Management Association, vol. 1(4), July.

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