Fair Pricing of Weather Derivatives

Eckhard Platen () and Jason West

No 106, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper proposes a consistent benchmark approach to price weather derivatives. The growth optimal portfolio to price weather derivatives. The growth optimal portfolio is used as numeraire such that all benchmarked fair price processes are martingales. No measure transformation is needed for fair pricing. Since weather derivatives are traded in an incomplete market setting, standard hedging based pricing methods cannot be applied. For weather derivative payoffs that are independent from the value of the growth optimal portfolio it is shown that the classical actuarial pricing methodology is a particular case of the fair pricing concept. A discrete time model is constructed to approximate historical weather characteristics assuming Gaussian residuals. For particular weather derivatives their fair prices are derived.

Keywords: weather derivatives; benchmark approach; growth optimal portfolio; fair pricing; actuarial pricing (search for similar items in EconPapers)
JEL-codes: C16 G10 G13 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2003-09-01
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Published as: Platen, E. and West, J., 2004, "Fair Pricing of Weather Derivatives", Asia-Pacific Financial Markets, 11(1), 23-53.

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Related works:
Journal Article: A Fair Pricing Approach to Weather Derivatives (2004)
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