Weather Derivative Pricing and the Normal Distribution: Comparing Three Fitting Schemes Using the Out-of-Sample Log-Likelihood Scoring System

9 Pages Posted: 12 Nov 2006

See all articles by Stephen Jewson

Stephen Jewson

Risk Management Solutions

Jeremy Penzer

London School of Economics

Date Written: November 10, 2006

Abstract

Many common weather indices are very close to being normally distributed, and it may be reasonable to assume they are exactly normally distributed for the purpose of pricing weather derivatives. Given that assumption, how should the indices be modelled? We use the expected out-of-sample log-likelihood score to compare 3 schemes: standing normal fitting, adjusted variance normal fitting, and the t-distribution.

Keywords: weather derivatives, normal distribution, variance estimators, t-distribution

JEL Classification: G13

Suggested Citation

Jewson, Stephen and Penzer, Jeremy, Weather Derivative Pricing and the Normal Distribution: Comparing Three Fitting Schemes Using the Out-of-Sample Log-Likelihood Scoring System (November 10, 2006). Available at SSRN: https://ssrn.com/abstract=944007 or http://dx.doi.org/10.2139/ssrn.944007

Stephen Jewson (Contact Author)

Risk Management Solutions ( email )

London EC3R 8NB
United Kingdom

Jeremy Penzer

London School of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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