MODELING AND PRICING PRECIPITATION DERIVATIVES UNDER WEATHER FORECASTS

Markus Hess ()
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Markus Hess: Université Libre de Bruxelles, Mathematics Department, Actuarial Sciences, CP 210, Boulevard du Triomphe, B-1050 Brussels, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2016, vol. 19, issue 07, 1-29

Abstract: We propose a pure jump precipitation model embedded in an enlarged filtration framework accounting for weather forecasts. Under different anticipative approaches, we define precipitation swap/futures prices and also introduce the notion of an “information premium”. In contrast to some other models in the literature, our forward-looking swap price representations admit time-varying stochastic dynamics. In these setups, swap price processes under the physical and risk-neutral measure turn out to be indistinguishable. We also consider an extended multi-location model measuring precipitation in several locations. In order to price options on precipitation derivatives under weather forecasts modeled by enlarged filtrations, we develop customized approximation procedures involving complex power series expansions and wavelet transform techniques.

Keywords: Anticipative stochastic calculus; stochastic differential equation; enlargement of filtration; information premium; forward-looking information; pure jump Lévy process; arithmetic model; weather market; precipitation derivative; weather forecast; option pricing; wavelet transform (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (5)

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DOI: 10.1142/S0219024916500515

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