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Can the market forecast the weather better than meteorologists?

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  • Matthias Ritter

Abstract

Many companies depend on weather conditions, so they require reliable weather forecasts for production planning or risk hedging. In this article, we propose a new way of gaining weather forecasts by exploiting the forward-looking information included in the market prices of weather derivatives traded at the Chicago Mercantile Exchange (CME). For this purpose, the CME futures prices of two monthly temperature indices relevant for the energy sector are compared with index forecasts derived from meteorological temperature forecasts. It turns out that the market prices generally outperform the meteorological forecasts in predicting the outcome of the monthly index. Hence, companies whose prot strongly depends on these indices, such as energy companies, can prot from this additional information source about future weather.

Suggested Citation

  • Matthias Ritter, 2012. "Can the market forecast the weather better than meteorologists?," SFB 649 Discussion Papers SFB649DP2012-067, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  • Handle: RePEc:hum:wpaper:sfb649dp2012-067
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    File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2012-067.pdf
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    References listed on IDEAS

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    1. Sailor, David J. & Muñoz, J.Ricardo, 1997. "Sensitivity of electricity and natural gas consumption to climate in the U.S.A.—Methodology and results for eight states," Energy, Elsevier, vol. 22(10), pages 987-998.
    2. Dorfleitner, Gregor & Wimmer, Maximilian, 2010. "The pricing of temperature futures at the Chicago Mercantile Exchange," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1360-1370, June.
    3. Svec, J. & Stevenson, M., 2007. "Modelling and forecasting temperature based weather derivatives," Global Finance Journal, Elsevier, vol. 18(2), pages 185-204.
    4. 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.
    5. Pardo, Angel & Meneu, Vicente & Valor, Enric, 2002. "Temperature and seasonality influences on Spanish electricity load," Energy Economics, Elsevier, vol. 24(1), pages 55-70, January.
    6. Roll, Richard, 1984. "Orange Juice and Weather," American Economic Review, American Economic Association, vol. 74(5), pages 861-880, December.
    7. Matthias Ritter & Oliver Mußhoff & Martin Odening, 2010. "Meteorological forecasts and the pricing of weather derivatives," SFB 649 Discussion Papers SFB649DP2010-043, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    8. Soares, Lacir J. & Medeiros, Marcelo C., 2008. "Modeling and forecasting short-term electricity load: A comparison of methods with an application to Brazilian data," International Journal of Forecasting, Elsevier, vol. 24(4), pages 630-644.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Forecasting the weather using the market
      by Economic Logician in Economic Logic on 2013-02-21 21:06:00

    More about this item

    Keywords

    Weather derivatives; weather forecasts; CME; energy sector;

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices
    • Q47 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy Forecasting

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