Weather Variance Risk Premia

Abstract

We analyze the information content of a variance risk premia extracted from the weather derivatives contracts written on the local temperature of individual U.S. cities. We term this the Weather Variance Risk Premia (WVRP). By constructing the WVRP measure from the CME’s weather futures and options contracts, we examine the role of weather variance risk on bond credit spreads of local corporations and municipalities. Our results indicate informativeness of weather derivatives market as a local risk factor priced in the bond returns of local corporations and municipalities. Our result is robust to controlling state level economic uncertainty measures.

Keywords: Weather Variance Risk Premia, Uncertainty, Municipal Bond, Corporate Bond, Stock Variance Risk Premia, Credit Spreads

JEL Classification: Q02, G13