THE PRICING OF DEGREE-DAY WEATHER OPTIONS

This paper presents a model and framework for pricing degree-day weather derivatives when the weather variable is a non-traded asset. Using daily weather data from 1840-1996 it is shown that a degree-day weather index exhibits stable volatility and satisfies the random walk hypothesis. The paper compares the options prices from the recommended model and compares it to a typical insurance-type model. The results show that the insurance model overprices the option value at-the-money and this may explain why the bid-ask spreads in the weather derivatives market is sometimes very large.


Issue Date:
2001
Publication Type:
Working or Discussion Paper
PURL Identifier:
http://purl.umn.edu/34109
Total Pages:
46
Series Statement:
Working Paper 02/05




 Record created 2017-04-01, last modified 2017-05-15

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