Dynamic valuation of weather derivatives under default risk

Wolfgang Härdle and Maria Osipenko

No 2017-005, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: Weather derivatives are contingent claims with payo based on a pre-speci ed weather index. Firms exposed to weather risk can transfer it to nancial markets via weather derivatives. We develop a utility-based model for pricing baskets of weather derivatives in over-the-counter markets under counterparty default risk. In our model, agents maximise the expected utility of their terminal wealth, while they dynamically rebalance their weather portfolios over a nite investment horizon. Via partial market clearing, we obtain semi-closed forms for the equilibrium prices of weather derivatives and for the optimal strategies of the agents. We give an example on how to price rainfall derivatives on selected stations in China in the universe of a nancial investor and a weather exposed crop insurer.

Keywords: derivative securities; asset pricing models (search for similar items in EconPapers)
Date: 2017
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