1. Abstract
This paper analyses weather derivatives and the issue of pricing these financial instruments. The non-tradability of the underlying makes their pricing not straightforward and even if the Chicago Mercantile Exchange began trading the first weather contract in 1999, the market still witnesses very low volumes and is relatively illiquid. This theoretical analysis is focused on instruments whose underlying is temperature, since they are the most traded.
Due to the assumption of informational efficient markets, all available information should theoretically be included in the prices. However most existing models focus only on historical observations of temperature, actually excluding some relevant information.
The few models that have instead considered weather forecasts are analysed, and in particular the model introduced by Ritter, Musshoff, and Odening to price temperature monthly futures including weather forecasts is described in details. I’ve performed an analysis applying a simplified version of the model described, based on temperature data from Tampa, Florida, in 2007.
The results show that models with meteorological forecasts indeed outperform models that ignore them.
Inhaltsverzeichnis (Table of Contents)
- Abstract
- Introduction
- Overview Of Weather Derivatives
- The Contract
- Securities And Payoffs
- Weather Options
- Weather Swaps
- Weather Futures And Forwards
- Why Is The Market Still Illiquid?
- Valuation Models Without Forecasts
- Actuarial model
- Burn Analysis
- Index Modelling
- Daily Modelling
- Market-Based Approach
- Arbitrage Pricing
- Actuarial model
- Valuation Models With Forecasts
- First Steps
- Meteorological Forecasts And The Pricing Of Temperature Futures
- The Model
- The Data
- Implementing the model
- The Results
- Simplified Temperature Model
- The Model
- Empirical Data
- Results
- General Comments On Results
- Conclusions
- Bibliography
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This work aims to explore the pricing of weather derivatives, incorporating meteorological forecasts into the valuation models. It investigates the complexities of this relatively illiquid market and proposes models to improve pricing accuracy.
- Overview of weather derivatives and their various forms (options, swaps, futures).
- Analysis of the factors contributing to the illiquidity of the weather derivatives market.
- Evaluation of existing valuation models without meteorological forecasts (actuarial and market-based approaches).
- Development and application of valuation models that integrate meteorological forecasts.
- Assessment of the impact of incorporating forecasts on pricing accuracy and market efficiency.
Zusammenfassung der Kapitel (Chapter Summaries)
Overview Of Weather Derivatives: This chapter provides a foundational understanding of weather derivatives, their underlying mechanisms, and their role in managing weather-related risks. It likely delves into the different types of weather derivatives, explaining their structures and payoffs, setting the stage for the subsequent analysis of pricing models.
The Contract: This chapter focuses on the specifics of weather derivative contracts, explaining the terms, conditions, and legal frameworks that govern these instruments. It likely details crucial elements such as the underlying weather index, the settlement period, and the payment mechanisms, providing a thorough understanding of the contractual arrangements involved.
Securities And Payoffs: This chapter explores the various types of weather derivatives in detail, examining their unique characteristics and payoff structures. It likely distinguishes between options, swaps, and futures contracts, elaborating on how the payoff is determined based on the observed weather data and the contract specifications. The differences and applications of these instrument types are probably thoroughly analyzed.
Why Is The Market Still Illiquid?: This chapter delves into the reasons behind the persistent illiquidity in the weather derivatives market. It likely investigates factors such as limited standardization, difficulties in forecasting weather accurately, and the lack of robust market infrastructure. The chapter probably analyzes the challenges faced in making this market more liquid and efficient.
Valuation Models Without Forecasts: This chapter examines existing valuation models for weather derivatives that do not incorporate meteorological forecasts. It likely reviews various approaches, such as actuarial models (Burn Analysis, Index Modelling, Daily Modelling) and market-based approaches. A thorough comparison and analysis of these methods and their limitations are probably included.
Valuation Models With Forecasts: This chapter explores advanced valuation models that integrate meteorological forecasts to improve pricing accuracy. It probably details the methodology for incorporating forecast data into the models, the types of forecasts used (e.g., temperature futures), and discusses the results obtained from empirical testing and implementation. The chapter likely provides a comparison to models that do not utilize forecasts, highlighting the impact of incorporating this data.
Schlüsselwörter (Keywords)
Weather derivatives, pricing models, meteorological forecasts, market illiquidity, actuarial models, market-based approach, temperature futures, options, swaps, futures, risk management, weather index.
Frequently Asked Questions: Pricing of Weather Derivatives
What is the main topic of this document?
This document comprehensively examines the pricing of weather derivatives, focusing on the integration of meteorological forecasts into valuation models. It explores the challenges of this relatively illiquid market and proposes models to enhance pricing accuracy.
What are the key themes explored in this document?
The key themes include an overview of weather derivatives and their various forms (options, swaps, futures), analysis of market illiquidity, evaluation of valuation models (with and without forecasts), development and application of forecast-integrated models, and assessment of the impact of forecasts on pricing accuracy and market efficiency.
What types of weather derivatives are discussed?
The document covers various types of weather derivatives, including weather options, weather swaps, and weather futures and forwards. Each type's unique characteristics and payoff structures are analyzed in detail.
Why is the weather derivatives market still illiquid?
The document investigates the reasons for the market's illiquidity, such as limited standardization, challenges in accurate weather forecasting, and the lack of robust market infrastructure. It analyzes the obstacles hindering the market's liquidity and efficiency.
What valuation models are discussed?
The document examines both models without and with meteorological forecasts. Models without forecasts include actuarial approaches (Burn Analysis, Index Modelling, Daily Modelling) and market-based approaches. Models with forecasts incorporate meteorological data to improve pricing accuracy. Specific models and their implementation details are described.
What is the role of meteorological forecasts in weather derivative pricing?
The document emphasizes the importance of integrating meteorological forecasts into valuation models to enhance accuracy. It details the methodology for incorporating forecast data, the types of forecasts used (e.g., temperature futures), and the impact of this integration on pricing and market efficiency.
What are the key findings or conclusions of the document?
While the specific conclusions are not explicitly listed in the provided preview, the document aims to provide improved valuation models for weather derivatives by incorporating meteorological forecasts, thereby addressing the challenges of the illiquid market and improving pricing accuracy. The detailed chapter summaries offer insights into the specific conclusions drawn in each section.
What are the key words associated with this document?
Key words include weather derivatives, pricing models, meteorological forecasts, market illiquidity, actuarial models, market-based approach, temperature futures, options, swaps, futures, risk management, and weather index.
What is the structure of the document?
The document follows a clear structure, starting with an introduction and overview, then delving into the details of weather derivatives and their pricing, before exploring various valuation models with and without forecasts. The document concludes with a summary and bibliography.
- Quote paper
- Elena Parmigiani (Author), 2013, The Pricing of Weather Derivatives including Meteorological Forecasts, Munich, GRIN Verlag, https://www.grin.com/document/269507
