Weather Derivative Pricing and the Detrending of Meteorological Data: Three Alternative Representations of Damped Linear Detrending
Risk Management Solutions
London School of Economics
January 24, 2005
It is often desirable to remove the trends from historical meteorological data prior to using that data for the pricing of weather derivatives. In previous articles we have introduced the method of damped linear detrending and argued that it is an effective way to remove trends when the trends are approximately linear. In this article we show that damped linear detrending can be interpreted in three different ways: as a mixture of the linear and flat-line models, as a linear model with the trend slope reduced, and as a linear model with reverse extrapolation.
Number of Pages in PDF File: 5
Keywords: weather derivatives, trends, detrending
JEL Classification: G12, G13
Date posted: January 24, 2005
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