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The pricing of degreeday weather options

The pricing of degreeday weather options 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Agricultural Finance Review Emerald Publishing

The pricing of degreeday weather options

Agricultural Finance Review , Volume 65 (1): 27 – May 5, 2005

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
0002-1466
DOI
10.1108/00214660580001167
Publisher site
See Article on Publisher Site

Abstract

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.

Journal

Agricultural Finance ReviewEmerald Publishing

Published: May 5, 2005

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