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Weather derivatives valuation and market price of weather risk

✍ Scribed by Melanie Cao; Jason Wei

Publisher
John Wiley and Sons
Year
2004
Tongue
English
Weight
195 KB
Volume
24
Category
Article
ISSN
0270-7314

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✦ Synopsis

Abstract

This paper has two objectives: (1) to propose and implement a valuation framework for temperature derivatives (a specific class of weather derivatives); and (2) to study the significance of the market price of weather risk. The objectives are accomplished by generalizing the Lucas model of 1978 to include the weather as another fundamental source of uncertainty in the economy. Daily temperature is modeled by incorporating such key properties as seasonal cycles and uneven variations throughout the year. The temperature variable is related to the aggregate dividend or output through both contemporaneous and lagged correlations, as corroborated by the data. Numerical analysis shows that the market price of weather risk is significant for temperature derivatives. Β© 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:1065–1089, 2004

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