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Pricing rainfall derivatives at the CME

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  • López Cabrera, Brenda
  • Odening, Martin
  • Ritter, Matthias

Abstract

Many business people such as farmers and financial investors are affected by indirect losses caused by scarce or abundant rainfall. Because of the high potential of insuring rainfall risk, the Chicago Mercantile Exchange (CME) began trading rainfall derivatives in 2011. Compared to temperature derivatives, however, pricing rainfall derivatives is more difficult. In this article, we propose to model rainfall indices via a flexible type of distribution, namely the normal-inverse Gaussian distribution, which captures asymmetries and heavy-tail behaviour. The prices of rainfall futures are computed by employing the Esscher transform, a wellknown tool in actuarial science. This approach is flexible enough to price any rainfall contract and to adjust theoretical prices to market prices by using the calibrated market price of risk. This empirical analysis is conducted with U.S. precipitation data and CME futures data providing first results on the market price of risk for rainfall derivatives.

Suggested Citation

  • López Cabrera, Brenda & Odening, Martin & Ritter, Matthias, 2013. "Pricing rainfall derivatives at the CME," SFB 649 Discussion Papers 2013-005, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    • Handle: RePEc:zbw:sfb649:sfb649dp2013-005
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    References listed on IDEAS

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    1. Bressan, Giacomo Maria & Romagnoli, Silvia, 2021. "Climate risks and weather derivatives: A copula-based pricing model," Journal of Financial Stability, Elsevier, vol. 54(C).

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    JEL classification:

    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • Q59 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Other

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