On Modelling and Pricing Weather Derivatives

The main objective of this work is to find a pricing model for weather derivatives with payouts depending on temperature. We use historical data to first suggest a stochastic process that describes the evolution of the temperature. Since temperature is a non-tradable quantity, we obtain unique prices of contracts in an incomplete market, using the market price of risk. Numerical examples of prices of some contracts are presented, using an approximation formula as well as Monte Carlo simulations.

Paper done in collaboration with Prof. Boualem Djehiche, at the Royal Institute of Technology in Stockholm, and presented at the Nordic Symposium on Contingent Claims, May 2001, at Stockholm School of Economics. Published in Applied Mathematical Finance, volume 9, Number 1/March 01, 2002.