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Alternative Approaches to Weather Derivatives Pricing

Geman, Hélyette; Leonardi, Marie-Pascale (2005), Alternative Approaches to Weather Derivatives Pricing, Managerial Finance, 31, 6, p. 46-72

Type
Article accepté pour publication ou publié
Date
2005-01
Journal name
Managerial Finance
Volume
31
Number
6
Publisher
MCB Journals
Pages
46-72
Metadata
Show full item record
Author(s)
Geman, Hélyette
Leonardi, Marie-Pascale
Abstract (EN)
The goal of the paper is to analyse the various issues attached to the valuation of weather derivatives. We focus our study on temperature-related contracts since they are the most widely traded at this point and try to address the following questions: (i) should the quantity underlying the swaps or options contracts be defined as the temperature, degree-days or cumulative degree-days? This discussion is conducted both in terms of the robustness of the statistical modelling of the state variable and the mathematical valuation of the option (European versus Asian). (ii) What pricing approaches can tackle the market incompleteness generated by a non-tradable underlying when furthermore the market price of risk is hard to identify in other traded instruments and unlikely to be zero? We illustrate our study on a database of temperatures registered at Paris Le Bourget and compare the calls and puts prices obtained using the different methods most widely used in weather markets.
Subjects / Keywords
Weather derivatives; Acceptable risk; Actuarial risk; Incomplete markets
JEL
G24 - Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
G11 - Portfolio Choice; Investment Decisions

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