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Portfolio Effects and Valuation of Weather Derivatives
Author(s) -
Brockett Patrick L.,
Wang Mulong,
Yang Chuanhou,
Zou Hong
Publication year - 2006
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.2006.00133.x
Subject(s) - portfolio , valuation (finance) , econometrics , stochastic game , derivative (finance) , asset (computer security) , economics , capital asset pricing model , replicating portfolio , actuarial science , financial economics , portfolio optimization , computer science , finance , microeconomics , computer security
In a mean‐variance framework, the indifference pricing approach is adopted to value weather derivatives, taking account of portfolio effects. Our analysis shows how the magnitude of portfolio effects is related to the correlation between weather indexes and other risky assets, the correlation between weather indexes, and the payoff structures of the existing weather derivatives in an investor's asset portfolio. We also conduct some preliminary empirical analysis. This study contributes to the weather derivative pricing literature by incorporating both the hedgeable and unhedgeable parts of weather risks in illustrating the portfolio effects on the indifference prices of weather derivatives.