Pricing Weather Derivatives Index based on Temperature: The Case of Bahir Dar,Ethiopia |
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| Authors: | Tesfahun BERHANE Aemiro SHIBABAW Gurju AWGICHEW |
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| Institution: | Department of mathematics, Bahir Dar University, Bahir Dar, P.O. Box79, Ethiopia |
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| Abstract: | In this paper we present a stochastic model for daily average temperature to calculate the temperature indices upon which temperature-based derivatives are written. We propose a seasonal mean and volatility model that describes the daily average temperature behavior using the mean-reverting Ornstein-Uhlenbeck process. We also use higher order continuous-time autoregressive process with lag 3 for modeling the time evolution of the temperatures after removing trend and seasonality. Our model is fitted to 11 years of data recorded, in the period 1 January 2005 to 31 December 2015, Bahir Dar, Ethiopia, obtained from Ethiopia National Meteorological Services Agency. The analytical approximation formulas are used to price heating degree days (HDD) and cooling degree days (CDD) futures. The suggested model is analytically tractable for derivation of explicit prices for CDD and HDD futures and option. The price of the CDD future is calculated, using analytical approximation formulas. Numerical examples are presented to indicate the accuracy of the method. The results show that our model performs better to predict CDD indices. |
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| Keywords: | continuous-time autoregressive model seasonality heating and cooling degree day indices Bahir Dar |
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