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The Pricing Of Degree-Day Weather Options

Author

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  • Turvey, Calum G.

Abstract

This paper presents a model and framework for pricing degree-day weather derivatives when the weather variable is a non-traded asset. Using daily weather data from 1840-1996 it is shown that a degree-day weather index exhibits stable volatility and satisfies the random walk hypothesis. The paper compares the options prices from the recommended model and compares it to a typical insurance-type model. The results show that the insurance model overprices the option value at-the-money and this may explain why the bid-ask spreads in the weather derivatives market is sometimes very large.

Suggested Citation

  • Turvey, Calum G., 2001. "The Pricing Of Degree-Day Weather Options," Working Papers 34109, University of Guelph, Department of Food, Agricultural and Resource Economics.
  • Handle: RePEc:ags:uguewp:34109
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    File URL: http://ageconsearch.umn.edu/record/34109/files/wp0205.pdf
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    References listed on IDEAS

    as
    1. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
    2. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    3. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Kellner, Ulla & Musshoff, Oliver, 2011. "Precipitation or water capacity indices? An analysis of the benefits of alternative underlyings for index insurance," Agricultural Systems, Elsevier, vol. 104(8), pages 645-653, October.

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    Keywords

    Marketing; Risk and Uncertainty;

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