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This paper presents a model and framework for pricing degreeday weather derivatives when the weather variable is a nontraded asset. Using daily weather data from 1840S1996, it is shown that a degreeday weather index exhibits stable volatility and satisfies the random walk hypothesis. The options prices from the recommended model are compared to a typical insurancetype model. The results show that the insurance model overprices the option value atthemoney, and this may explain why the bidask spread in the weather derivatives market is sometimes very large.
Agricultural Finance Review – Emerald Publishing
Published: May 5, 2005
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