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Pricing Chinese rain: a multi-site multi-period equilibrium pricing model for rainfall derivatives

Wolfgang Härdle and Maria Osipenko
Authors registered in the RePEc Author Service: Wolfgang Karl Härdle ()

SFB 649 Discussion Papers from Humboldt University, Collaborative Research Center 649

Abstract: Many industries are exposed to weather risk which they can transfer on financial markets via weather derivatives. Equilibrium models based on partial market clearing became a useful tool for pricing such kind of financial instruments. In a multi-period equilibrium pricing model agents rebalance their portfolio of weather bonds and a risk free asset in each period such that they maximize the expected utility of their incomes constituted by possibly weather dependent profits and payoffs of portfolio positions. We extend the model to a multisite version and apply it to pricing rainfall derivatives for Chinese provinces. By simulating realistic market conditions with two agent types, farmers with profits highly exposed to weather risk and a financial investor diversifying her financial portfolio, we obtain equilibrium prices for weather derivatives on cumulative monthly rainfall. Dynamic portfolio optimization under market clearing and utility indifference of these representative agents determines equilibrium quantity and price for rainfall derivatives.

Keywords: rainfall derivatives; equilibrium pricing; space-time Markov model (search for similar items in EconPapers)
JEL-codes: C22 C51 G13 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2011-08
New Economics Papers: this item is included in nep-agr and nep-cmp
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