Pricing Weather Derivatives

Posted: 8 Oct 2004

See all articles by Timothy J. Richards

Timothy J. Richards

Arizona State University W. P. Carey School of Business

Mark R. Manfredo

Arizona State University - Morrison School of Agribusiness and Resource Management

Dwight R. Sanders

Southern Illinois University - Agribusiness Economics

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Abstract

This article presents a general method for pricing weather derivatives. Specification tests find that a temperature series for Fresno, CA follows a mean-reverting Brownian motion process with discrete jumps and autoregressive conditional heteroscedastic errors. Based on this process, we define an equilibrium pricing model for cooling degree day weather options. Comparing option prices estimated with three methods: a traditional burn-rate approach, a Black-Scholes-Merton approximation, and an equilibrium Monte Carlo simulation reveals significant differences. Equilibrium prices are preferred on theoretical grounds, so are used to demonstrate the usefulness of weather derivatives as risk management tools for California specialty crop growers.

Suggested Citation

Richards, Timothy J. and Manfredo, Mark Ronald and Sanders, Dwight R., Pricing Weather Derivatives. Available at SSRN: https://ssrn.com/abstract=595051

Timothy J. Richards (Contact Author)

Arizona State University W. P. Carey School of Business ( email )

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Mesa, AZ 85212
United States
480-727-1148 (Phone)

HOME PAGE: http://www.east.asu.edu/msabr/faculty/richards.htm

Mark Ronald Manfredo

Arizona State University - Morrison School of Agribusiness and Resource Management ( email )

7001 E. Williams Field Road
Mesa, AZ 85212
480-727-1040 (Phone)
480-727-1961 (Fax)

Dwight R. Sanders

Southern Illinois University - Agribusiness Economics ( email )

Carbondale, IL 62901-4515
United States
618-453-1711 (Phone)

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