Temperature Models for Pricing Weather Derivatives

Quantitative Finance, Vol.12, No. 3, March 2012, 489-500

24 Pages Posted: 11 Oct 2008 Last revised: 18 May 2012

See all articles by Frank Schiller

Frank Schiller

MunichRe

Gerold Seidler

affiliation not provided to SSRN

Maximilian Wimmer

University of Regensburg; University of Mannheim - Finance Area

Date Written: March 11, 2010

Abstract

We present four models for predicting temperatures that can be used for pricing weather derivatives. Three of the models have been suggested in prior literature, and we suggest another model which uses splines to remove trend and seasonality effects from temperature time series in a flexible way. Using historical temperature data from 35 weather stations across the United States, we test the performance of the models by evaluating virtual heating degree days (HDD) and cooling degree days (CDD) contracts. We find that all models perform better when predicting HDD indices than predicting CDD indices. However, all models based on a daily simulation approach significantly underestimate the variance of the errors.

Keywords: Weather derivatives, temperature, heating degree days, cooling degree days, daily simulation

JEL Classification: C52, G13, Q40

Suggested Citation

Schiller, Frank and Seidler, Gerold and Wimmer, Maximilian, Temperature Models for Pricing Weather Derivatives (March 11, 2010). Quantitative Finance, Vol.12, No. 3, March 2012, 489-500, Available at SSRN: https://ssrn.com/abstract=1280826 or http://dx.doi.org/10.2139/ssrn.1280826

Frank Schiller

MunichRe ( email )

Königinstr. 107
Munich, 80802
Germany

Gerold Seidler

affiliation not provided to SSRN ( email )

Maximilian Wimmer (Contact Author)

University of Regensburg ( email )

Universitaetsstrasse 31
Regensburg, 93053
Germany
+49 941 943 2672 (Phone)

HOME PAGE: http://www-finance.uni-regensburg.de/Team/Maximilian-Wimmer.html

University of Mannheim - Finance Area ( email )

Mannheim, 68131
Germany

HOME PAGE: http://cf.bwl.uni-mannheim.de/

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