The Pricing of Temperature Futures at the Chicago Mercantile Exchange

28 Pages Posted: 9 Dec 2009 Last revised: 31 Mar 2011

See all articles by Gregor Dorfleitner

Gregor Dorfleitner

University of Regensburg - Department of Finance

Maximilian Wimmer

University of Regensburg; University of Mannheim - Finance Area

Date Written: August 28, 2009

Abstract

This paper analyzes observed prices of U.S. temperature futures at the Chicago Mercantile Exchange (CME). Results show that an index modeling approach without detrending captures the prices exceptionally well. Moreover, weather forecasts significantly influence prices up to 11 days ahead. It is shown that valuations of temperature futures relying on a model without detrending yield biased valuations by overpricing winter contracts and underpricing summer contracts. Several trading strategies are devised to exploit the mispricing observed at the CME and to demonstrate that speculating on temperature futures can not only generate high overall returns, but also perform well on a risk-adjusted basis.

Keywords: Weather derivatives, Index modeling, Weather forecast, Futures pricing, Trading strategy

JEL Classification: C53, G13, G29, Q54

Suggested Citation

Dorfleitner, Gregor and Wimmer, Maximilian, The Pricing of Temperature Futures at the Chicago Mercantile Exchange (August 28, 2009). Journal of Banking and Finance, Vol. 34, No.6, pp. 1360-1370, 2010, Available at SSRN: https://ssrn.com/abstract=1520067

Gregor Dorfleitner

University of Regensburg - Department of Finance ( email )

Regensburg, 93040
Germany

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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