Pricing of Asian temperature risk
Weather derivatives (WD) are different from most financial derivatives because the underlying weather cannot be traded and therefore cannot be replicated by other financial instruments. The market price of risk (MPR) is an important parameter of the associated equivalent martingale measures used to price and hedge weather futures/options in the market. The majority of papers so far have priced non-tradable assets assuming zero MPR, but this assumption underestimates WD prices. We study the MPR structure as a time dependent object with concentration on emerging markets in Asia. We find that Asian Temperatures (Tokyo, Osaka, Beijing, Teipei) are normal in the sense that the driving stochastics are close to a Wiener Process. The regression residuals of the temperature show a clear seasonal variation and the volatility term structure of CAT temperature futures presents a modified Samuelson effect. In order to achieve normality in standardized residuals, the seasonal variation is calibrated with a combination of a fourier truncated series with a GARCH model and with a local linear regression. By calibrating model prices, we implied the MPR from Cumulative total of 24- hour average temperature futures (C24AT) for Japanese Cities, or by knowing the formal dependence of MPR on seasonal variation, we price derivatives for Kaohsiung, where weather derivative market does not exist. The findings support theoretical results of reverse relation between MPR and seasonal variation of temperature process.
|Date of creation:||Oct 2009|
|Contact details of provider:|| Postal: Spandauer Str. 1,10178 Berlin|
Web page: http://sfb649.wiwi.hu-berlin.de
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- FRED ESPEN BENTH & JŪRATĖ SALTYTĖ BENTH & STEEN KOEKEBAKKER, 2007. "Putting a Price on Temperature," Scandinavian Journal of Statistics, Danish Society for Theoretical Statistics;Finnish Statistical Society;Norwegian Statistical Association;Swedish Statistical Association, vol. 34(4), pages 746-767.
- Eckhard Platen & Jason West, 2004.
"A Fair Pricing Approach to Weather Derivatives,"
Asia-Pacific Financial Markets,
Springer;Japanese Association of Financial Economics and Engineering, vol. 11(1), pages 23-53, March.
- Eckhard Platen & Jason West, 2003. "Fair Pricing of Weather Derivatives," Research Paper Series 106, Quantitative Finance Research Centre, University of Technology, Sydney.
- Richards, Timothy J. & Manfredo, Mark R. & Sanders, Dwight R., 2004. "Pricing Weather Derivatives," Working Papers 28536, Arizona State University, Morrison School of Agribusiness and Resource Management.
- Turvey, Calum G., 1999. "The Essentials Of Rainfall Derivatives And Insurance," Working Papers 34149, University of Guelph, Department of Food, Agricultural and Resource Economics.
- Turvey, Calum, 1999. "The Essentials Of Rainfall Derivatives And Insurance," Working Papers 244738, University of Guelph, Department of Food, Agricultural and Resource Economics.
- 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.
- Sean D. Campbell & Francis X. Diebold, 2005. "Weather Forecasting for Weather Derivatives," Journal of the American Statistical Association, American Statistical Association, vol. 100, pages 6-16, March.
- 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).
- Sean D. Campbell & Francis X. Diebold, 2003. "Weather Forecasting for Weather Derivatives," NBER Working Papers 10141, National Bureau of Economic Research, Inc.
- 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.
- Dorje Brody & Joanna Syroka & Mihail Zervos, 2002. "Dynamical pricing of weather derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 2(3), pages 189-198.
- Hélène Hamisultane, 2007. "Extracting Information from the Market to Price the Weather Derivatives," Working Papers halshs-00079192, HAL.
- M. Davis, 2001. "Pricing weather derivatives by marginal value," Quantitative Finance, Taylor & Francis Journals, vol. 1(3), pages 305-308, March.
- Dwight R. Sanders, 2004. "Pricing Weather Derivatives," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 86(4), pages 1005-1017.
- 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.
- Hung‐Hsi Huang & Yung‐Ming Shiu & Pei‐Syun Lin, 2008. "HDD and CDD option pricing with market price of weather risk for Taiwan," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(8), pages 790-814, 08. Full references (including those not matched with items on IDEAS)