A closed-form approximation for pricing temperature-based weather derivatives
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Description
This paper develops analytical distributions of temperature indices on which temperature derivatives are written. If the deviations of daily temperatures from their expected values are modelled as an Ornstein-Uhlenbeck process with timevarying variance, then the distributions of the temperature index on which the derivative is written is the sum of truncated, correlated Gaussian deviates. The key result of this paper is to provide an analytical approximation to the distribution of this sum, thus allowing the accurate computation of payoffs without the need for any simulation. A data set comprising average daily temperature spanning over a hundred years for four Australian cities is used to demonstrate the efficacy of this approach for estimating the payoffs to temperature derivatives. It is demonstrated that expected payoffs computed directly from historical records are a particularly poor approach to the problem when there are trends in underlying average daily temperature. It is shown that the proposed analytical approach is superior to historical pricing.
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ID Code: | 219929 | ||||
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Item Type: | Contribution to Journal (Journal Article) | ||||
Refereed: | Yes | ||||
ORCID iD: |
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Measurements or Duration: | 14 pages | ||||
Keywords: | Cooling-Degree Days, Distributions for Correlated Variables, Temperature Models, Weather Derivatives | ||||
DOI: | 10.4236/am.2013.49182 | ||||
ISSN: | 2152-7393 | ||||
Pure ID: | 32552761 | ||||
Divisions: | Past > QUT Faculties & Divisions > QUT Business School Current > Schools > School of Economics & Finance |
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Copyright Owner: | Consult author(s) regarding copyright matters | ||||
Copyright Statement: | This work is covered by copyright. Unless the document is being made available under a Creative Commons Licence, you must assume that re-use is limited to personal use and that permission from the copyright owner must be obtained for all other uses. If the document is available under a Creative Commons License (or other specified license) then refer to the Licence for details of permitted re-use. It is a condition of access that users recognise and abide by the legal requirements associated with these rights. If you believe that this work infringes copyright please provide details by email to qut.copyright@qut.edu.au | ||||
Deposited On: | 06 Nov 2021 11:42 | ||||
Last Modified: | 06 Mar 2024 13:05 |
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