Pricing temperature-based weather contracts: an application to China

Abstract

This article is the first study to price temperature-based weather derivatives based on the daily average temperatures of Chinese cities, namely Beijing, Shanghai and Shenzhen. A dynamic model with a piecewise constant volatility function, proposed by Alaton et al. (2002), is used for pricing Heating Degree Days (HDD) and Cooling Degree Days (CDD) options. Price estimates for these options are obtained using Monte Carlo simulation and analytical approximation methods.