Forecast Based Pricing of Weather Derivatives

SFB 649 Discussion Paper 2012-027

25 Pages Posted: 7 Jan 2017

See all articles by Wolfgang K. Härdle

Wolfgang K. Härdle

Humboldt University of Berlin - Institute for Statistics and Econometrics; Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE)

Brenda López Cabrera

Humboldt University of Berlin

Matthias Ritter

Humboldt-Universität zu Berlin - Department of Agricultural Economics

Date Written: March 15, 2012

Abstract

Forecasting based pricing of Weather Derivatives (WDs) is a new approach in valuation of contingent claims on nontradable underlyings. Standard techniques are based on historical weather data. Forward-looking information such as meteorological forecasts or the implied market price of risk (MPR) are often not incorporated. We adopt a risk neutral approach (for each location) that allows the incorporation of meteorological forecasts in the framework of WD pricing. We study weather Risk Premiums (RPs) implied from either the information MPR gain or the meteorological forecasts. The size of RPs is interesting for investors and issuers of weather contracts to take advantages of geographic diversification, hedging effects and price determinations. By conducting an empirical analysis to London and Rome WD data traded at the Chicago Mercantile Exchange (CME), we find out that either incorporating the MPR or the forecast outperforms the standard pricing techniques.

Keywords: weather derivatives, seasonal variation, temperature, risk premia

JEL Classification: G19, G29, G22, N23, N53, Q59

Suggested Citation

Härdle, Wolfgang K. and Cabrera, Brenda López and Ritter, Matthias, Forecast Based Pricing of Weather Derivatives (March 15, 2012). SFB 649 Discussion Paper 2012-027. Available at SSRN: https://ssrn.com/abstract=2894218 or http://dx.doi.org/10.2139/ssrn.2894218

Wolfgang K. Härdle (Contact Author)

Humboldt University of Berlin - Institute for Statistics and Econometrics ( email )

Unter den Linden 6
Berlin, D-10099
Germany
+49 30 2093 5631 (Phone)
+49 30 2093 5649 (Fax)

Humboldt University of Berlin - Center for Applied Statistics and Economics (CASE)

Unter den Linden 6
Berlin, D-10099
Germany

Brenda López Cabrera

Humboldt University of Berlin

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

Matthias Ritter

Humboldt-Universität zu Berlin - Department of Agricultural Economics ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

HOME PAGE: http:// https://hu.berlin/mritter

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