A Study on the Market Price of Weather Risk in Pricing Weather Derivatives

Abstract

The weather largely affects economic activity, and thus, companies vulnerable to weather risk need to plan ahead to cope with unexpected weather changes, just as they do for changes in interest rates, oil prices, or foreign exchange rates to stabilize their earning stream. Weather derivatives can be a useful tool for weather risk management. This paper focuses on pricing one of the most popular weather derivatives -HDD/CDD options- and estimating the market price of weather risk (MPR). Historical data are used to construct the stochastic process of temperature, while the current market prices of Chicago and New York HDD futures options are used to extract the implied MPR. The Monte-Carlo Simulation Method is proposed to estimate the price of weather derivatives numerically. In addition, the approximate closed form formula for the options is provided modifying the Alaton, Djehiche, and Stillberg (2002) model. Finally, option price sensitivity to changes in MPR is analyzed to show the important role of the MPR in the weather option pricing model.

قياس أثر إدراك العاملين بالبنوك المصرية لأهمية استخدام المشتقات المالية للتغيرات المناخية على كفاءة وفاعلية إدارة المخاطر بالبنك - دراسة مقارنة

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Analysis of Offset Emission Permit Pricing Factors in the Korean Carbon Market

“…If a variable is integrated with I(2) or higher, the 1 Based on 2019 production amount, 64% of large enterprises, 36% of small and medium-sized enterprises (Ministry of SMEs and Startups, 2019)2 The Heating degree days index (HDD) and Cooling degree days index (CDD) are the most actively used indices in weather derivative trading. The calculation is following (Bae and Choung, 2009). HDD = Max(18℃ − 𝑇 𝑖 , 0), 𝐶DD = Max(𝑇 𝑖 − 18℃, 0)T i = T max − T min 2 , T max = Daily maximum temperature, T min = Daily minimum temperature…”