Modeling Temperature and Pricing Weather Derivatives Based on Temperature

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2017-01-01

Author

Tastan, Birhan
Hayfavi, Azize

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This study first proposes a temperature model to calculate the temperature indices upon which temperature-based derivatives are written. The model is designed as a mean-reverting process driven by a Levy process to represent jumps and other features of temperature. Temperature indices are mainly measured as deviations from a base temperature, and, hence, the proposed model includes jumps because they may constitute an important part of this deviation for some locations. The estimated value of a temperature index and its distribution in this model apply an inversion formula to the temperature model. Second, this study develops a pricing process over calculated index values, which returns a customized price for temperature-based derivatives considering that temperature has unique effects on every economic entity. This personalized price is also used to reveal the trading behavior of a hypothesized entity in a temperature-based derivative trade with profit maximization as the objective. Thus, this study presents a new method that does not need to evaluate the risk-aversion behavior of any economic entity.

Subject Keywords

Meteorology & Atmospheric Sciences

URI

https://hdl.handle.net/11511/30400

Journal

ADVANCES IN METEOROLOGY

DOI

https://doi.org/10.1155/2017/3913817

Collections

Graduate School of Applied Mathematics, Article

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Citation Formats

B. Tastan and A. Hayfavi, “Modeling Temperature and Pricing Weather Derivatives Based on Temperature,” ADVANCES IN METEOROLOGY, pp. 0–0, 2017, Accessed: 00, 2020. [Online]. Available: https://hdl.handle.net/11511/30400.