Pricing Weather Derivatives

This paper presents a general method for pricing weather derivatives. Specification tests find that a temperature series for Fresno, California follows a mean-reverting Brownian motion process with discrete jumps and ARCH errors. Based on this process, we define an equilibrium pricing model for cooling degree day weather options. Comparing option prices estimated with three methods: a traditional burn-rate approach, a Black-Scholes-Merton approximation, and an equilibrium Monte Carlo simulation reveals significant differences. Equilibrium prices are preferred on theoretical grounds, so are used to demonstrate the usefulness of weather derivatives as risk management tools for California specialty crop growers.


Issue Date:
2004
Publication Type:
Working or Discussion Paper
PURL Identifier:
http://purl.umn.edu/28536
Total Pages:
40
Series Statement:
Working Paper MSABR 04-2




 Record created 2017-04-01, last modified 2017-08-24

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