Weather Derivative Pricing and the Impact of El Nino on Us Temperature: Empirical Tests of an Optimal Categorical Forecasting Scheme

Abstract

Weather derivative pricing for US locations can potentially be improved through the judicious use of seasonal forecasts. However, the number of El Nino and La Nina events that appear in the historical record is small and for many locations the signals are weak. We run some simulation-based tests of an optimal categorical forecasting scheme that takes the small sample size and weak signal into account and tries to produce RMSE-optimal seasonal forecasts.

Keywords: Weather derivatives, ENSO, El Nino, La Nina, seasonal forecasts

JEL Classification: G12, G13