Modeling Temperature and Pricing Weather Derivatives Based on Temperature

الملخص EN

This study first proposes a temperature model to calculate the temperature indices upon which temperature-based derivatives are written.

The model is designed as a mean-reverting process driven by a Levy process to represent jumps and other features of temperature.

Temperature indices are mainly measured as deviations from a base temperature, and, hence, the proposed model includes jumps because they may constitute an important part of this deviation for some locations.

The estimated value of a temperature index and its distribution in this model apply an inversion formula to the temperature model.

Second, this study develops a pricing process over calculated index values, which returns a customized price for temperature-based derivatives considering that temperature has unique effects on every economic entity.

This personalized price is also used to reveal the trading behavior of a hypothesized entity in a temperature-based derivative trade with profit maximization as the objective.

Thus, this study presents a new method that does not need to evaluate the risk-aversion behavior of any economic entity.