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Pricing Rainfall Derivatives at the CME

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Author Info

  • Brenda López Cabrera
  • Martin Odening
  • Matthias Ritter

Abstract

Many business people such as farmers and financial investors are affected by indirect losses caused by scarce or abundant rainfall. Because of the high potential of insuring rainfall risk, the Chicago Mercantile Exchange (CME) began trading rainfall derivatives in 2011. Compared to temperature derivatives, however, pricing rainfall derivatives is more difficult. In this article, we propose to model rainfall indices via a flexible type of distribution, namely the normal-inverse Gaussian distribution, which captures asymmetries and heavy-tail behaviour. The prices of rainfall futures are computed by employing the Esscher transform, a wellknown tool in actuarial science. This approach is flexible enough to price any rainfall contract and to adjust theoretical prices to market prices by using the calibrated market price of risk. This empirical analysis is conducted with U.S. precipitation data and CME futures data providing first results on the market price of risk for rainfall derivatives.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2013-005.

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Length: 27 pages
Date of creation: Jan 2013
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2013-005

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Related research

Keywords: Weather derivatives; precipitation; Esscher transform; market price of risk;

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References

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Cited by:
  1. Friedrich Poeschel, 2013. "Assortative matching through signals," 2013 Papers ppo178, Job Market Papers.

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