Weather Derivatives and the Market Price of Risk

Abstract

Weather derivatives are becoming prominent features in multiasset class portfolios of alternative risk. The pricing of these securities is nonetheless challenging since it requires an incomplete market framework. We discuss pricing formulas for temperature-based weather derivative options, constructing mean reverting stochastic models for describing the dynamics of daily temperature with a constant speed of mean reversion for three cities. Truncated Fourier series are used to model the volatility, and assuming a constant market price of risk, we introduce a novel approach for estimating this constant, using Monte Carlo simulations.

Pricing Quanto Options in Renewable Energy Markets

“…There are many past studies researched on weather derivatives contracts. For example, Esunge and Njong [20], Tastan and Hayfavi [34] and Wang et al [37] had been introduced to cover the risk exposure from weather conditions with different approaches such as the Ornstein-Uhlenbeck process and Monte Carlo simulations. In addition, Cui and Anatoliy [14] also conducted a study analyzing various types of weather-related risks in different industries.…”

Weedy Finance: Weather Insurance and Parametric Life on Unstable Grounds

“…But in another sense, they depart from conventional insurance contracts, as they do not indemnify losses (Kar 2017)—they are a weather hedge rather than crop insurance. Thus, critical insurance studies have argued that parametric insurance acts less like an insurance scheme that depends on an adjustor evaluating casualty claims ( siniestros ) for verified crop losses, and more like a weather derivative (Esunge and Njong 2020). The contracts are written on a climate model and decoupled from actual farms and fields, as the plants themselves become dematerialized into abstract biomass.…”