Weather Derivative Pricing and a Preliminary Investigation into a Decision Rule for Detrending

Abstract

Weather derivative pricing is often based on year-ahead forecasts of the weather made using simple statistical models and past weather data. Two of the simplest models in common use are the flat line and linear trend models. We consider the question of how to choose between these two models and test a simple decision rule based on closed-form expressions for the RMSE.

Keywords: Weather derivatives, detrending, global warming

JEL Classification: G12, G13