Pricing And Simulation Of Weather Derivatives Based On Temperature

General weather risk is an uncertainty fluctuation on business income due to the temperature, rain, frost and other causes. It is a kind of quantity risk. Traditional risk management tools can not be good to avoid such risk, but weather derivatives are unique, they can play an important role on weather risk management.In this thesis, the author firstly defines the concept of weather risk, and introduces the management strategies on weather risk management. Then, there is a comprehensive introduction of weather derivatives from the basis types, market actors, trading modes, the relations and differences between traditional derivatives and so on. By analyzing and comparing the general pricing methods of weather derivatives based on temperature, it is considered that using the Monte Carlo method through expected returns to pricing weather derivatives is appropriate.The simulation of the subject matter is an important aspect on pricing weather derivatives, so choosing the right model is crucial. Based on the reading and analyzing of domestic and foreign relative literatures, the article chooses weather derivatives based on temperature as study object, and uses two representative methods:time series mothod and mean-reversion method to simulate the stochastic process of temperature. The average temperature data of Wuhan city from the year1990to2009were used to estimate the model parameters, and data from January1,2010to November30,2010were used for a comparison. Result shows that the two models can describe the temperature stochastic process well, and the volatility of forecasting data is lower than the actual temperature. Moreover, the time series model based on ARMA fits the actual data better than the mean-reversion model.Then, by considering the contracts compensate features of weather derivertives based on temperature, and using the Monte Carlo pricing method, the article presents the pricing formula of weather futures and weather options based on temperature and by simulation experiment with the ARMA model, the price of CDDs futures and CDDs options based on temperature are given.In China, there is a huge market demand on weather derivatives, and now more and more scholars pay attentions to the study of weather derivatives. Launching the weather derivative products timely has a practical feasibility, it will not only beneficial to weather related business, but also improve the level of investment in China’s financial market.