Consistent Factor Models For Temperature Markets
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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Volume (Year): 15 (2012)
Issue (Month): 04 ()
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References listed on IDEAS
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- Peter Alaton & Boualem Djehiche & David Stillberger, 2002. "On modelling and pricing weather derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(1), pages 1-20.
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- Helyette Geman & M. Leonardi, 2005. "Alternative Approaches to Weather Derivatives Pricing," Post-Print halshs-00144304, HAL.
- Dorje Brody & Joanna Syroka & Mihail Zervos, 2002. "Dynamical pricing of weather derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 2(3), pages 189-198.
- Eckhard Platen & Jason West, 2003.
"Fair Pricing of Weather Derivatives,"
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106, Quantitative Finance Research Centre, University of Technology, Sydney.
- Sean D. Campbell & Francis X. Diebold, 2003.
"Weather Forecasting for Weather Derivatives,"
NBER Working Papers
10141, National Bureau of Economic Research, Inc.
- Sean D. Campbell & Francis X. Diebold, 2002. "Weather Forecasting for Weather Derivatives," Center for Financial Institutions Working Papers 02-42, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Campbell, Sean D. & Diebold, Francis X., 2004. "Weather forecasting for weather derivatives," CFS Working Paper Series 2004/10, Center for Financial Studies (CFS).
- M. Davis, 2001. "Pricing weather derivatives by marginal value," Quantitative Finance, Taylor & Francis Journals, vol. 1(3), pages 305-308, March.
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