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On Modelling and Pricing Rainfall Derivatives with Seasonality

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  • Gunther Leobacher
  • Philip Ngare
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    Abstract

    We are interested in pricing rainfall options written on precipitation at specific locations. We assume the existence of a tradeable financial instrument in the market whose price process is affected by the quantity of rainfall. We then construct a suitable 'Markovian gamma' model for the rainfall process which accounts for the seasonal change of precipitation and show how maximum likelihood estimators can be obtained for its parameters. We derive optimal strategies for exponential utility from terminal wealth and determine the utility indifference price of the claim. The method is illustrated with actual measured data on rainfall from a location in Kenya and spot prices of Kenyan electricity companies.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13504861003795167
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

    Volume (Year): 18 (2011)
    Issue (Month): 1 ()
    Pages: 71-91

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    Handle: RePEc:taf:apmtfi:v:18:y:2011:i:1:p:71-91

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    Web page: http://www.tandfonline.com/RAMF20

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    Web: http://www.tandfonline.com/pricing/journal/RAMF20

    Related research

    Keywords: Rainfall derivatives; Seasonality; Discrete-time Markov control process; Utility indifference pricing; Monte Carlo methods;

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    Cited by:
    1. López Cabrera, Brenda & Odening, Martin & Ritter, Matthias, 2013. "Pricing rainfall futures at the CME," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4286-4298.
    2. Brenda López Cabrera & Martin Odening & Matthias Ritter, 2013. "Pricing Rainfall Derivatives at the CME," SFB 649 Discussion Papers SFB649DP2013-005, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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