Portfolio Effects and Valuation of Weather Derivatives

22 Pages Posted: 20 Nov 2006

See all articles by Patrick L. Brockett

Patrick L. Brockett

University of Texas at Austin - Department of Information, Risk and Operations Management

Mulong Wang

University of Texas at Austin

Charles C. Yang

Florida Atlantic University

Hong Zou

Lingnan University, Department of Finance and Insurance

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Abstract

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 derivative 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.

Suggested Citation

Brockett, Patrick L. and Wang, Mulong and Yang, Charles C. and Zou, Hong, Portfolio Effects and Valuation of Weather Derivatives. The Financial Review, Vol. 41, No. 1, pp. 55-76, February 2006, Available at SSRN: https://ssrn.com/abstract=945501 or http://dx.doi.org/10.1111/j.1540-6288.2006.00133.x

Patrick L. Brockett

University of Texas at Austin - Department of Information, Risk and Operations Management ( email )

CBA 5.202
Austin, TX 78712
United States

Mulong Wang

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

Charles C. Yang (Contact Author)

Florida Atlantic University ( email )

777 Glades Road
Boca Raton, FL 33431
United States

Hong Zou

Lingnan University, Department of Finance and Insurance ( email )

Castle Peak Road
Tuen Mun, New Territories
Hong Kong
China

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