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Consistent Factor Models For Temperature Markets

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Author Info

  • PHILIPP HELL

    ()
    (Mathematical Institute, University of Munich, Theresienstrasse 39, 80333 Munich, Germany)

  • THILO MEYER-BRANDIS

    ()
    (Mathematical Institute, University of Munich, Theresienstrasse 39, 80333 Munich, Germany)

  • THORSTEN RHEINLÄNDER

    ()
    (Department of Statistics, London School of Economics and Political Science, Houghton Street, London WC2A 2AE, UK)

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    Abstract

    We propose an approach for pricing and hedging weather derivatives based on including forward looking information about the temperature available to the market. This is achieved by modeling temperature forecasts by a finite dimensional factor model. Temperature dynamics are then inferred in the short end. In analogy to interest rate theory, we establish conditions which guarantee consistency of a factor model with the martingale dynamics of temperature forecasts. Finally, we consider a specific two-factor model and examine in more detail pricing and hedging of weather derivatives in this context.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 15 (2012)
    Issue (Month): 04 ()
    Pages: 1250027-1-1250027-24

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    Handle: RePEc:wsi:ijtafx:v:15:y:2012:i:04:p:1250027-1-1250027-24

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    Related research

    Keywords: Temperature models; temperature markets; factor models; consistency; temperature derivatives; pricing and hedging;

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    Cited by:
    1. Andreas Groll & Brenda López-Cabrera & Thilo Meyer-Brandis, 2014. "A consistent two-factor model for pricing temperature derivatives," SFB 649 Discussion Papers SFB649DP2014-006, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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