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The Pricing Of Degree-Day Weather Options

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Author Info
Turvey, Calum G.
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 1840-1996 it is shown that a degree-day weather index exhibits stable volatility and satisfies the random walk hypothesis. The paper compares the options prices from the recommended model and compares it 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 spreads in the weather derivatives market is sometimes very large.

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File URL: http://purl.umn.edu/34109
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Publisher Info
Paper provided by University of Guelph, Department of Food, Agricultural and Resource Economics in its series Working Papers with number 34109.

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Date of creation: 2001
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Handle: RePEc:ags:uguewp:34109

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Web page: http://fare.uoguelph.ca/
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Related research
Keywords: weather derivatives; degree-day options; weather risk; Marketing; Risk and Uncertainty;

References listed on IDEAS
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  1. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179. [Downloadable!] (restricted)
  2. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166. [Downloadable!] (restricted)
  3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
  4. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November. [Downloadable!] (restricted)
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This page was last updated on 2009-12-11.

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