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Pricing of temperature-based weather options for Turkey

Author

Listed:
  • Ahmet GÖNCÜ

    (Shandong University)

  • Mehmet Oguz KARAHAN

    (Bogazici Universitesi)

  • Tolga Umut KUZUBAŞ

    (Bogazici Universitesi)

Abstract

Weather derivatives provide better risk management alternatives for industries, which are exposed to weather-based risks. Dynamic pricing of weather derivatives requires a suitable underlying temperature model. This paper is the first to model the average daily temperatures and prices of heating/cooling degree days (HDD/CDD) option contracts for Istanbul, Turkey. We model daily average temperatures using the mean-reverting Ornstein-Uhlenbeck (OU) process both with constant and time-varying mean reversion parameters. HDD/CDD options for Istanbul are priced using analytical approximation and Monte Carlo simulations. In most cases estimates are lower when time-varying mean reversion model is used. We also discuss several issues on the importance of weather derivatives markets for developing countries.

Suggested Citation

  • Ahmet GÖNCÜ & Mehmet Oguz KARAHAN & Tolga Umut KUZUBAŞ, 2011. "Pricing of temperature-based weather options for Turkey," Iktisat Isletme ve Finans, Bilgesel Yayincilik, vol. 26(309), pages 33-50.
  • Handle: RePEc:iif:iifjrn:v:26:y:2011:i:309:p:33-50
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    Cited by:

    1. Ahmet Goncu & Mehmet Oguz Karahan & Tolga Umut Kuzubas, 2013. "Forecasting Daily Residential Natural Gas Consumption: A Dynamic Temperature Modelling Approach," Working Papers 2013/11, Bogazici University, Department of Economics.

    More about this item

    Keywords

    Weather Contracts; Temperature Modelling; Monte Carlo Simulation; HDD/CDD Options;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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