Pricing Temperature Weather Derivatives

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: The key aim of the current paper is to analyse the plausibility of a pricing model for temperature weather derivatives. The historical data are studied in order to propose a stochastic process that describes temperature dynamics in three Swedish cities. The prices of the contracts in an incomplete market of weather derivatives are obtained using a constant positive market price of risk of a benchmark temperature derivative. Numerical examples of prices of contracts are shown using Monte-Carlo simulations and an approximation formula. The precision of the approximation formula is scrutinized depending on the changes in strike, market price of risk, risk-free rate, mean temperature, speed of mean-reversion and volatility. Moreover, theoretical prices of temperature options for two Swedish cities, which are not represented on the weather derivative market, are proposed.

  AT THIS PAGE YOU CAN DOWNLOAD THE WHOLE ESSAY. (follow the link to the next page)