Portfolio Effects and Valuation of Weather Derivatives
Posted: 10 Nov 2005
In a mean-variance framework, the indifference pricing approach is adopted to value weather derivatives, taking account of portfolio effects. Our analysis shows how the magnitude of portfolio effects is related to the correlation between weather indexes and other risky assets, the correlation between weather indexes, and the payoff structures of the existing weather derivatives in an investor's asset portfolio. We also conduct some preliminary empirical analysis. This study contributes to the weather derivatives-pricing literature by incorporating both the hedgeable and unhedgeable parts of weather risks in illustrating the portfolio effects on the indifference prices of weather derivatives.
Keywords: weather derivatives, weather risk securitization, incomplete market pricing models, weather risk contract valuation, portfolio effects, indifference prices
JEL Classification: G12, G13
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