Pricing rainfall futures at the CME

Brenda López Cabrera, Martin Odening and Matthias Ritter

Journal of Banking & Finance, 2013, vol. 37, issue 11, 4286-4298

Abstract: Many business people such as farmers and financial investors are affected by indirect losses caused by scarce or abundant rainfall. Because of the high potential of insuring rainfall risk, the Chicago Mercantile Exchange (CME) began trading rainfall derivatives in 2011. Compared to temperature derivatives, however, pricing rainfall derivatives is more difficult. In this article, we propose to model rainfall indices via a flexible type of distribution, namely the normal-inverse Gaussian distribution, which captures asymmetries and heavy-tail behaviour. The prices of rainfall futures are computed by employing the Esscher transform, a well-known tool in actuarial science. This approach is flexible enough to price any rainfall contract and to adjust theoretical prices to market prices by using the calibrated market price of risk. The empirical analysis is conducted with US precipitation data and CME futures data providing first results on the market price of risk for rainfall derivatives.

Keywords: Weather derivatives; Precipitation; Esscher transform; Market price of risk (search for similar items in EconPapers)
JEL-codes: G19 G22 G29 Q59 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:11:p:4286-4298

DOI: 10.1016/j.jbankfin.2013.07.042

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