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Pricing Weather Derivatives Using the Indifference Pricing Approach

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  • Patrick Brockett
  • Linda Goldens
  • Min-Ming Wen
  • Charles Yang

Abstract

This paper adopts an incomplete market pricing model–the indifference pricing approach–to analyze valuation of weather derivatives and the viability of the weather derivatives market in a hedging context. It incorporates price risk, weather/quantity risk, and other risks in the financial market. In a mean-variance framework, the relationship between the actuarial price and the indifference price of weather derivatives is analyzed, and conditions are obtained concerning when the actuarial price does not provide an appropriate valuation for weather derivatives. Conditions for the viability of the weather derivatives market are examined. This paper also analyzes the effects of partial hedging, natural hedges, basis risk, quantity risk, and price risk on investors’ indifference prices by examining the distributional impacts of the stochastic variables involved.

Suggested Citation

  • Patrick Brockett & Linda Goldens & Min-Ming Wen & Charles Yang, 2009. "Pricing Weather Derivatives Using the Indifference Pricing Approach," North American Actuarial Journal, Taylor & Francis Journals, vol. 13(3), pages 303-315.
    • Handle: RePEc:taf:uaajxx:v:13:y:2009:i:3:p:303-315
    DOI: 10.1080/10920277.2009.10597556
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    3. Evarest Emmanuel & Berntsson Fredrik & Singull Martin & Yang Xiangfeng, 2018. "Weather derivatives pricing using regime switching model," Monte Carlo Methods and Applications, De Gruyter, vol. 24(1), pages 13-27, March.
    4. Asante Gyamerah, Samuel & Ngare, Philip & Ikpe, Dennis, 2018. "A Levy Regime-Switching Temperature Dynamics Model for Weather Derivatives," MPRA Paper 89680, University Library of Munich, Germany, revised 10 Jul 2018.
    5. Jiakun Zheng, 2020. "Optimal insurance design under narrow framing," Post-Print hal-04227370, HAL.
    6. Nelson Christopher Dzupire & Philip Ngare & Leo Odongo, 2019. "Pricing Basket Weather Derivatives on Rainfall and Temperature Processes," IJFS, MDPI, vol. 7(3), pages 1-14, June.
    7. Zheng, Jiakun, 2020. "Optimal insurance design under narrow framing," Journal of Economic Behavior & Organization, Elsevier, vol. 180(C), pages 596-607.

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