Weather Derivatives and Seasonal Forecasts

초록

The CPC (Climate Prediction Center) seasonal outlook can be incorporated into a simulation model of the temperature process so that the conditional mean and the conditional variance of the temperature and CDD (Cooling Degree Days) may be determined for a given set of seasonal outlook probabilities. The temperature process is assumed to follow the Ornstein-Uhlenbeck process, which is a Gaussian process, and hence CDD also follows a Gaussian process. The option price for the CDD weather derivatives can be easily derived using the normality property of the underlying density when there is no truncation for temperatures below 65. Using the temperature data for five cities on the East Coast of the USA in the case where there is no truncation in the temperature process, the Monte Carlo simulation shows the appropriate accuracy, which means that the CDD option values obtained through both the pricing formula and the Monte Carlo simulation are close together. In cases where temperature paths less than 65℉ are truncated the option values obtained by the Monte Carlo simulation are very sensitive to the seasonal outlook probabilities. This is because the density of CDD over a summer season, conditional on the seasonal outlook, shifts a large amount as a result of the truncation of temperature.

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