Weather Forecasting for Weather Derivatives

45 Pages Posted: 22 Dec 2002

See all articles by Sean D. Campbell

Sean D. Campbell

Board of Governors of the Federal Reserve System

Francis X. Diebold

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: December 4, 2002

Abstract

We take a nonstructural time-series approach to modeling and forecasting daily average temperature in ten U.S. cities, and we inquire systematically as to whether it may prove useful from the vantage point of participants in the weather derivatives market. The answer is, perhaps surprisingly, yes. Time series modeling reveals both strong conditional mean dynamics and conditional variance dynamics in daily average temperature, and it reveals sharp differences between the distribution of temperature and the distribution of temperature surprises. Most importantly, it adapts readily to produce the long-horizon forecasts of relevance in weather derivatives contexts. We produce and evaluate both point and distributional forecasts of average temperature, with some success. We conclude that additional inquiry into nonstructural weather forecasting methods, as relevant for weather derivatives, will likely prove useful.

Note: An earlier version of this paper can be downloaded at http://ssrn.com/abstract=284950

Keywords: Risk Management, Hedging, Insurance, Seasonality, Average Temperature, Financial Derivatives, Density Forecasting

JEL Classification: G0, C1

Suggested Citation

Campbell, Sean D. and Diebold, Francis X., Weather Forecasting for Weather Derivatives (December 4, 2002). Available at SSRN: https://ssrn.com/abstract=359663 or http://dx.doi.org/10.2139/ssrn.359663

Sean D. Campbell

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francis X. Diebold (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-1507 (Phone)
215-573-4217 (Fax)

HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

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