Pricing of Weather Derivatives
It is estimated that up the variability in US economic activity due to weather variability could be 3.4%, or $485 billion (of the 2008 GDP). Thus, weather derivatives serve as a hedge to protect against losses incurred due to to adverse weather events. We focus on pricing temperature derivatives, more precisely a Heating Degree Days Option for the Q1 Seasonal Strip (Jan, Feb, Mar) for the city of Baltimore. We do so by developing a temperature model using a combination of deterministic time series analysis and SDEs.