Forecast based Pricing of Weather Derivatives
AbstractForecasting based pricing of Weather Derivatives (WDs) is a new approach in valuation of contingent claims on nontradable underlyings. Standard techniques are based on historical weather data. Forward-looking information such as meteorological forecasts or the implied market price of risk (MPR) are often not incorporated. We adopt a risk neutral approach (for each location) that allows the incorporation of meteorological forecasts in the framework of WD pricing. We study weather Risk Premiums (RPs) implied from either the information MPR gain or the meteorological forecasts. The size of RPs is interesting for investors and issuers of weather contracts to take advantages of geographic diversification, hedging effects and price determinations. By conducting an empirical analysis to London and Rome WD data traded at the Chicago Mercantile Exchange (CME), we find out that either incorporating the MPR or the forecast outperforms the standard pricing techniques.
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Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2012-027.
Length: 25 pages
Date of creation: Mar 2012
Date of revision:
Weather derivatives; seasonal variation; temperature; risk premia;
Find related papers by JEL classification:
- G19 - Financial Economics - - General Financial Markets - - - Other
- G29 - Financial Economics - - Financial Institutions and Services - - - Other
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- N23 - Economic History - - Financial Markets and Institutions - - - Europe: Pre-1913
- N53 - Economic History - - Agriculture, Natural Resources, Environment and Extractive Industries - - - Europe: Pre-1913
- Q59 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Other
This paper has been announced in the following NEP Reports:
- NEP-AGR-2013-02-08 (Agricultural Economics)
- NEP-ALL-2013-02-08 (All new papers)
- NEP-FOR-2013-02-08 (Forecasting)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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