A Regime switching model for the temperature and pricing weather derivatives

Download
2016
Türkvatan, Aysun
Weather has an enormous impact on many institutions, for example, in energy, agriculture, or tourism sectors. For example, a gas provider faces the reduced demand in gas in case of hot winter. Weather derivatives can be used as a tool to manage the risk exposure towards adverse or unexpected weather conditions. Weather derivatives are the financial contracts with underlying depending on weather variables such as temperature,humidity,precipitationorsnow. Sincethetemperatureisthemostcommonly used weather variable, we consider the temperature based weather derivatives. These are the financial contracts written on several temperature indices, such as the cumulative average temperature (CAT), or the cooling degree days (CDD). We first propose a regime-switching model for the temperature dynamics, where the parameters depend on a Markov chain. Also, since the jumps in the temperature are directly related to the regime switch, we model them by the chain itself. Morever, the estimation and forecast of the proposed model is considered. It is shown that forecast performance of the proposed model is in line with the existing models considered. After modeling the temperature dynamics, to price the derivatives, the risk-neutral probability is to be specified. Since temperature (and hence the index) is not a tradeable asset, any probability measure being equivalent to the objective probability is a risk-neutral probability. We consider a generalized version of the Esscher transform to select an equivalent measure. Then we derive prices of weather derivatives written on several temperature indices.

Suggestions

A Novel Wind Power Forecast Model: Statistical Hybrid Wind Power Forecast Technique (SHWIP)
Ozkan, Mehmet; Karagöz, Pınar (Institute of Electrical and Electronics Engineers (IEEE), 2015)
As the result of increasing population and growing technological activities, nonrenewable energy sources, which are the main energy providers, are diminishing day by day. Due to this factor, efforts on efficient utilization of renewable energy sources have increased all over the world. Wind is one of the most significant alternative energy resources. However, in comparison with other renewable energy sources, it is so variable that there is a need for estimating and planning of wind power generation. In thi...
Modeling temperature and pricing weather derivatives based on temperature
Taştan, Birhan; Hayfavi, Azize; Department of Financial Mathematics (2016)
Weather Derivatives are financial contracts prepared to reduce weather risks faced by economic actors to regulate cash flows and protect earnings. The weather derivatives may be in the forms of options, futures, swaps, and bonds whose payout are dependent on some weather indices. The firms in the sectors like energy, insurance, agriculture, construction use weather derivatives mostly. Weather derivatives are different than the traditional financial derivatives on several occasions. Traditional financial der...
A new data mining based upscaling approach for regional wind power forecasting
Özkan, Mehmet Barış; Karagöz, Pınar; Department of Computer Engineering (2021-2-8)
Together with the increasing need for energy, the importance of renewable energy sources has been increasing day by day. Although wind is one of the most important alternative energy sources due to its high potential, it is not a stable source since it depends on the weather conditions. So, in order to include the power produced by the wind into electricity grid with planned manner, it must be predicted accurately beforehand. To produce a reliable wind power forecast, getting a Wind Power Plant’s (WPP) powe...
Evaluation of the best management practices in a semi-arid region with high agricultural activity
Özcan, Zeynep; Kentel Erdoğan, Elçin; Alp, Emre (Elsevier BV, 2017-12)
The arid and semi-arid regions with water scarcity are vulnerable to several stressors such as urbanization, high water demand created by agricultural and industrial activities, point and non-point pollution sources, and climate change. Hence, proactive policies and sustainable water management strategies that are based on decision support systems are crucial in arid and semi-arid regions. Because of large expenses and implementation difficulties associated with the diffuse pollution abatement plans, many a...
A pathway to identifying and valuing cultural ecosystem services: An application to marine food webs
Baulcomb, Corinne; Fletcher, Ruth; Lewis, Amy; Akoğlu, Ekin; Robinson, Leonie; von Almen, Amanada; Hussain, Salman; Glenk, Klaus (2015-02-01)
Beyond recreation, little attention has been paid thus far to economically value Cultural Ecosystem Services (CESs), especially in the context of coastal or marine environment. This paper develops and tests a pathway to the identification and economic valuation of CESs. The pathway enables researchers to make more explicit, and to economically value, cultural dimensions of environmental change. We suggest that the valuation process includes a simultaneous development of the scenarios of environmental change...
Citation Formats
A. Türkvatan, “A Regime switching model for the temperature and pricing weather derivatives,” Ph.D. - Doctoral Program, Middle East Technical University, 2016.