A Stochastic Harmonic Oscillator Temperature Model for the Valuation of Weather Derivatives

Alessio Giorgini, Rogemar S. Mamon and Marianito R. Rodrigo
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Alessio Giorgini: Chief Risk Officer Department, FinecoBank, 20131 Milan, Italy
Rogemar S. Mamon: Department of Statistical and Actuarial Sciences, University of Western Ontario, London, ON N6A 5B7, Canada
Marianito R. Rodrigo: School of Mathematics and Applied Statistics, University of Wollongong, Wollongong, NSW 2522, Australia

Mathematics, 2021, vol. 9, issue 22, 1-15

Abstract: Stochastic processes are employed in this paper to capture the evolution of daily mean temperatures, with the goal of pricing temperature-based weather options. A stochastic harmonic oscillator model is proposed for the temperature dynamics and results of numerical simulations and parameter estimation are presented. The temperature model is used to price a one-month call option and a sensitivity analysis is undertaken to examine how call option prices are affected when the model parameters are varied.

Keywords: weather derivatives; stochastic models; temperature; harmonic oscillator; parameter estimation (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2021
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