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Modeling and Pricing in Financial Markets for Weather Derivatives

Author

Listed:
  • Fred Espen Benth

    (University of Oslo, Norway)

  • Jūratė Šaltytė Benth

    (University of Oslo, Norway)

Abstract

Weather derivatives provide a tool for weather risk management, and the markets for these exotic financial products are gradually emerging in size and importance. This unique monograph presents a unified approach to the modeling and analysis of such weather derivatives, including financial contracts on temperature, wind and rain. Based on a deep statistical analysis of weather factors, sophisticated stochastic processes are introduced modeling the time and space dynamics. Applying ideas from the modern theory of mathematical finance, weather derivatives are priced, and questions of hedging analyzed. The treatise contains an in-depth analysis of typical weather contracts traded at the Chicago Mercantile Exchange (CME), including so-called CDD and HDD futures. The statistical analysis of weather variables is based on a large data set from Lithuania.

Individual chapters are listed in the "Chapters" tab

Suggested Citation

  • Fred Espen Benth & Jūratė Šaltytė Benth, 2012. "Modeling and Pricing in Financial Markets for Weather Derivatives," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 8457, January.
    • Handle: RePEc:wsi:wsbook:8457
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    References listed on IDEAS

    as
    1. Richard E. Chandler & Steven Bate, 2007. "Inference for clustered data using the independence loglikelihood," Biometrika, Biometrika Trust, vol. 94(1), pages 167-183.
    2. Fred Espen Benth & Jurate Saltyte-Benth, 2005. "Stochastic Modelling of Temperature Variations with a View Towards Weather Derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(1), pages 53-85.
    3. Ma, Chunsheng, 2003. "Nonstationary covariance functions that model space-time interactions," Statistics & Probability Letters, Elsevier, vol. 61(4), pages 411-419, February.
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    6. A. Zapranis & A. Alexandridis, 2008. "Modelling the Temperature Time-dependent Speed of Mean Reversion in the Context of Weather Derivatives Pricing," Applied Mathematical Finance, Taylor & Francis Journals, vol. 15(4), pages 355-386.
    7. Jewson,Stephen & Brix,Anders With contributions by-Name:Ziehmann,Christine, 2005. "Weather Derivative Valuation," Cambridge Books, Cambridge University Press, number 9780521843713.
    8. Pavel Cizek & Wolfgang Karl Härdle & Rafal Weron, 2005. "Statistical Tools for Finance and Insurance," HSC Books, Hugo Steinhaus Center, Wroclaw University of Technology, number hsbook0501.
    9. Fred Espen Benth, 2003. "On arbitrage-free pricing of weather derivatives based on fractional Brownian motion," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(4), pages 303-324.
    10. Benth, Fred Espen & Saltyte Benth, Jurate, 2009. "Dynamic pricing of wind futures," Energy Economics, Elsevier, vol. 31(1), pages 16-24, January.
    11. Andrea Barth & Fred Espen Benth & Jurgen Potthoff, 2011. "Hedging of Spatial Temperature Risk with Market-Traded Futures," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(2), pages 93-117.
    12. Svec, J. & Stevenson, M., 2007. "Modelling and forecasting temperature based weather derivatives," Global Finance Journal, Elsevier, vol. 18(2), pages 185-204.
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    16. Jurate Saltyte Benth & Fred Espen Benth, 2010. "Analysis and modelling of wind speed in New York," Journal of Applied Statistics, Taylor & Francis Journals, vol. 37(6), pages 893-909.
    17. Lun, Isaac Y.F & Lam, Joseph C, 2000. "A study of Weibull parameters using long-term wind observations," Renewable Energy, Elsevier, vol. 20(2), pages 145-153.
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    20. Ma, Chunsheng, 2003. "Spatio-temporal stationary covariance models," Journal of Multivariate Analysis, Elsevier, vol. 86(1), pages 97-107, July.
    21. David J. Nott, 2002. "Estimation of nonstationary spatial covariance structure," Biometrika, Biometrika Trust, vol. 89(4), pages 819-829, December.
    22. Schwartz, Eduardo S, 1997. "The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
    23. Melanie Cao & Jason Wei, 2004. "Weather derivatives valuation and market price of weather risk," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(11), pages 1065-1089, November.
    24. Patrick E. Brown & Peter J. Diggle & Martin E. Lord & Peter C. Young, 2001. "Space–time calibration of radar rainfall data," Journal of the Royal Statistical Society Series C, Royal Statistical Society, vol. 50(2), pages 221-241.
    25. Barnett, Barry J. & Barrett, Christopher B. & Skees, Jerry R., 2008. "Poverty Traps and Index-Based Risk Transfer Products," World Development, Elsevier, vol. 36(10), pages 1766-1785, October.
    26. 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.
    27. Ole E. Barndorff–Nielsen & Fred Espen Benth & Almut E. D. Veraart, 2010. "Modelling electricity forward markets by ambit fields," CREATES Research Papers 2010-41, Department of Economics and Business Economics, Aarhus University.
    28. Fred Benth & Wolfgang Karl Härdle & Brenda López Cabrera, 2009. "Pricing of Asian temperature risk," SFB 649 Discussion Papers SFB649DP2009-046, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    29. Dorje Brody & Joanna Syroka & Mihail Zervos, 2002. "Dynamical pricing of weather derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 2(3), pages 189-198.
    30. Jurate saltyte Benth & Fred Espen Benth & Paulius Jalinskas, 2007. "A Spatial-temporal Model for Temperature with Seasonal Variance," Journal of Applied Statistics, Taylor & Francis Journals, vol. 34(7), pages 823-841.
    31. Barry J. Barnett & Olivier Mahul, 2007. "Weather Index Insurance for Agriculture and Rural Areas in Lower-Income Countries," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 89(5), pages 1241-1247.
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    33. M. Davis, 2001. "Pricing weather derivatives by marginal value," Quantitative Finance, Taylor & Francis Journals, vol. 1(3), pages 305-308, March.
    34. Michael L. Stein, 2005. "Space-Time Covariance Functions," Journal of the American Statistical Association, American Statistical Association, vol. 100, pages 310-321, March.
    35. Ole E. Barndorff–Nielsen & Fred Espen Benth & Almut E. D. Veraart, 2010. "Modelling energy spot prices by Lévy semistationary processes," CREATES Research Papers 2010-18, Department of Economics and Business Economics, Aarhus University.
    36. René Carmona & Pavel Diko, 2005. "Pricing Precipitation Based Derivatives," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(07), pages 959-988.
    37. Fred ESPEN Benth & Jurate saltyte Benth, 2007. "The volatility of temperature and pricing of weather derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 7(5), pages 553-561.
    38. Teddy Oetomo & Max Stevenson, 2005. "Hot or Cold? A Comparison of Different Approaches to the Pricing of Weather Derivatives," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 4(2), pages 101-133, August.
    39. P. Brockwell, 2001. "Lévy-Driven Carma Processes," Annals of the Institute of Statistical Mathematics, Springer;The Institute of Statistical Mathematics, vol. 53(1), pages 113-124, March.
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    41. Rehman, Shafiqur & Halawani, Talal Omar, 1994. "Statistical characteristics of wind in Saudi Arabia," Renewable Energy, Elsevier, vol. 4(8), pages 949-956.
    42. Wolfgang Karl Härdle & Brenda López Cabrera, 2012. "The Implied Market Price of Weather Risk," Applied Mathematical Finance, Taylor & Francis Journals, vol. 19(1), pages 59-95, February.
    43. Skees, Jerry R., 2008. "Innovations in Index Insurance for the Poor in Lower Income Countries," Agricultural and Resource Economics Review, Northeastern Agricultural and Resource Economics Association, vol. 37(1), pages 1-15, April.
    44. Helyette Geman & M. Leonardi, 2005. "Alternative Approaches to Weather Derivatives Pricing," Post-Print halshs-00144304, HAL.
    45. Gneiting T., 2002. "Nonseparable, Stationary Covariance Functions for Space-Time Data," Journal of the American Statistical Association, American Statistical Association, vol. 97, pages 590-600, June.
    46. repec:dau:papers:123456789/1386 is not listed on IDEAS
    47. Šaltytė Benth, Jūratė & Benth, Fred Espen, 2012. "A critical view on temperature modelling for application in weather derivatives markets," Energy Economics, Elsevier, vol. 34(2), pages 592-602.
    48. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    49. Ole E. Barndorff‐Nielsen & Neil Shephard, 2001. "Non‐Gaussian Ornstein–Uhlenbeck‐based models and some of their uses in financial economics," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 63(2), pages 167-241.
    50. Skees, Jerry R., 2008. "Innovations in Index Insurance for the Poor in Lower Income Countries," Agricultural and Resource Economics Review, Cambridge University Press, vol. 37(1), pages 1-15, April.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Simona Franzoni & Cristian Pelizzari, 2021. "Rainfall option impact on profits of the hospitality industry through scenario correlation and copulas," Annals of Operations Research, Springer, vol. 299(1), pages 939-962, April.
    2. Fei Gao & Shuaiqiang Liu & Cornelis W. Oosterlee & Nico M. Temme, 2022. "Solution of integrals with fractional Brownian motion for different Hurst indices," Papers 2203.02323, arXiv.org, revised Mar 2022.
    3. Markus Hess, 2021. "A new approach to wind power futures pricing," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 1235-1252, December.
    4. Groll, Andreas & López-Cabrera, Brenda & Meyer-Brandis, Thilo, 2016. "A consistent two-factor model for pricing temperature derivatives," Energy Economics, Elsevier, vol. 55(C), pages 112-126.
    5. Aleksejus Kononovicius & Rytis Kazakeviv{c}ius & Bronislovas Kaulakys, 2022. "Resemblance of the power-law scaling behavior of a non-Markovian and nonlinear point processes," Papers 2205.07563, arXiv.org, revised Jul 2022.
    6. Július Bemš & Caner Aydin, 2022. "Introduction to weather derivatives," Wiley Interdisciplinary Reviews: Energy and Environment, Wiley Blackwell, vol. 11(3), May.
    7. Deschatre, Thomas & Féron, Olivier & Gruet, Pierre, 2021. "A survey of electricity spot and futures price models for risk management applications," Energy Economics, Elsevier, vol. 102(C).
    8. Yeny E. Rodríguez & Miguel A. Pérez-Uribe & Javier Contreras, 2021. "Wind Put Barrier Options Pricing Based on the Nordix Index," Energies, MDPI, vol. 14(4), pages 1-14, February.
    9. Johannes Kaufmann & Philipp Artur Kienscherf & Wolfgang Ketter, 2020. "Modeling and Managing Joint Price and Volumetric Risk for Volatile Electricity Portfolios," Energies, MDPI, vol. 13(14), pages 1-19, July.
    10. Fred Espen Benth & Marco Piccirilli & Tiziano Vargiolu, 2017. "Additive energy forward curves in a Heath-Jarrow-Morton framework," Papers 1709.03310, arXiv.org, revised Jun 2018.
    11. Aur'elien Alfonsi & Nerea Vadillo, 2023. "Risk valuation of quanto derivatives on temperature and electricity," Papers 2310.07692, arXiv.org.
    12. Abbaspour, Manijeh & Vajargah, Kianoush Fathi & Azhdari, Parvin, 2023. "An efficient algorithm for pricing reinsurance contract under the regime-switching model," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 211(C), pages 278-300.
    13. Fred Espen Benth & Asma Khedher & Michèle Vanmaele, 2020. "Pricing of Commodity Derivatives on Processes with Memory," Risks, MDPI, vol. 8(1), pages 1-32, January.
    14. Fred Espen Benth & Luca Di Persio & Silvia Lavagnini, 2018. "Stochastic Modeling of Wind Derivatives in Energy Markets," Risks, MDPI, vol. 6(2), pages 1-21, May.
    15. Wolfgang Karl Härdle & Brenda López Cabrera & Awdesch Melzer, 2021. "Pricing wind power futures," Journal of the Royal Statistical Society Series C, Royal Statistical Society, vol. 70(4), pages 1083-1102, August.
    16. Kononovicius, Aleksejus & Kazakevičius, Rytis & Kaulakys, Bronislovas, 2022. "Resemblance of the power-law scaling behavior of a non-Markovian and nonlinear point processes," Chaos, Solitons & Fractals, Elsevier, vol. 162(C).
    17. Fred Espen Benth & Sara Ana Solanilla Blanco, 2015. "Forward Prices As Functionals Of The Spot Path In Commodity Markets Modeled By Levy Semistationary Processes," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(02), pages 1-35.
    18. Sonja Cox & Sven Karbach & Asma Khedher, 2022. "An infinite‐dimensional affine stochastic volatility model," Mathematical Finance, Wiley Blackwell, vol. 32(3), pages 878-906, July.
    19. Fred Espen Benth & Asma Khedher & Mich`ele Vanmaele, 2017. "Pricing of commodity derivatives on processes with memory," Papers 1711.00307, arXiv.org.

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