Estimating the Payoffs of Temperature-based Weather Derivatives
Temperature-based weather derivatives are written on an index which is normally defined to be a nonlinear function of average daily temperatures. Recent empirical work has demonstrated the usefulness of simple time-series models of temperature for estimating the payoffs to these instruments. This paper argues that a more direct and parsimonious approach is to model the time-series behaviour of the index itself, provided a sufficiently rich supply of historical data is available. A data set comprising average daily temperature spanning over a hundred years for four Australian cities is assembled. The data is then used to compare the actual payoffs of temperature-based European call options with the expected payoffs computed from historical temperature records and two time-series approaches. It is concluded that expected payoffs computed directly from historical records perform poorly by comparison with the expected payoffs generated by means of competing time-series models. It is also found that modeling the relevant temperature index directly is superior to modeling average daily temperatures.
|Date of creation:||26 Aug 2008|
|Date of revision:|
|Contact details of provider:|| Phone: 07 3138 5066|
Fax: 07 3138 1500
Web page: http://www.ncer.edu.au
More information through EDIRC
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.:
- 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.
- Sean D. Campbell & Francis X. Diebold, 2003. "Weather Forecasting for Weather Derivatives," NBER Working Papers 10141, National Bureau of Economic Research, Inc.
- Campbell, Sean D. & Diebold, Francis X., 2004. "Weather forecasting for weather derivatives," CFS Working Paper Series 2004/10, Center for Financial Studies (CFS).
- 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.
- 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.
- Eckhard Platen & Jason West, 2003.
"Fair Pricing of Weather Derivatives,"
Research Paper Series
106, Quantitative Finance Research Centre, University of Technology, Sydney.
When requesting a correction, please mention this item's handle: RePEc:qut:auncer:2008-22. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (School of Economics and Finance)The email address of this maintainer does not seem to be valid anymore. Please ask School of Economics and Finance to update the entry or send us the correct address
If references are entirely missing, you can add them using this form.