Top

Mathematics and Financial Economics

Published in:

16-05-2019

A regime switching model for temperature modeling and applications to weather derivatives pricing

Authors: Aysun Türkvatan, Azize Hayfavi, Tolga Omay

Published in: Mathematics and Financial Economics | Issue 1/2020

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

In this study, we propose a regime-switching model for temperature dynamics, where the parameters depend on a Markov chain. We improve upon the traditional models by modeling jumps in temperature dynamics via the chain itself. Moreover, we compare the performance of the proposed model with the existing models. The results indicate that the proposed model outperforms in the short time forecast horizon while the forecast performance of the proposed model is in line with the existing models for the long time horizon. It is shown that the proposed model is a relatively better representation of temperature dynamics compared to the existing models. Furthermore, we derive prices of weather derivatives written on several temperature indices.

next article Fractional risk process in insurance

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Available only for authorised users

Alaton, P., Djehiche, B., Stillberger, D.: On modelling and pricing weather derivatives. Appl. Math. Finance 9(1), 1–20 (2002)MATHCrossRef

Alexandridis, A.K., Zapranis, A.D.: The weather derivatives market. In: Weather Derivatives, pp. 1–20. Springer, New York, NY (2013). https://doi.org/10.1007/978-1-4614-6071-8_1 MATH

Benth, F.E., Šaltytė Benth, J.: Stochastic modelling of temperature variations with a view towards weather derivatives. Appl. Math. Finance 12(1), 53–85 (2005)MATHCrossRef

Benth, F.E., Šaltytė Benth, J.: The volatility of temperature and pricing of weather derivatives. Quant. Finance 7(5), 553–561 (2007)MathSciNetMATHCrossRef

Benth, F.E., Šaltytė Benth, J.: Weather derivatives and stochastic modelling of temperature. Int. J. Stoch. Anal. (2011). https://doi.org/10.1155/2011/576791 MathSciNetMATHCrossRef

Benth, F.E., Šaltytė Benth, J.: Modeling and Pricing in Financial Markets for Weather Derivatives, vol. 17. World Scientific, Singapore (2013)MATH

Benth, F.E., Šaltytė Benth, J., Koekebakker, S.: Putting a price on temperature. Scand. J. Stat. 34(4), 746–767 (2007)MathSciNetMATH

Bo, L., Capponi, A.: Optimal investment under information driven contagious distress. SIAM J. Control Optim. 55(2), 1020–1068 (2017)MathSciNetMATHCrossRef

Brody, D.C., Syroka, J., Zervos, M.: Dynamical pricing of weather derivatives. Quant. Finance 2(3), 189–198 (2002)MathSciNetMATHCrossRef

10.

Buffington, J., Elliott, R.J.: American options with regime switching. Int. J. Theor. Appl. Finance 5(05), 497–514 (2002)MathSciNetMATHCrossRef

11.

Cappé, O., Moulines, E., Rydén, T.: Inference in Hidden Markov Models. Springer, New York (2005)MATHCrossRef

12.

Carr, P., Madan, D.: Option valuation using the fast Fourier transform. J. Comput. Finance 2(4), 61–73 (1999)CrossRef

13.

CME: Weather products, http://www.cmegroup.com/trading/weather/ (2016). Accessed July 2016

14.

Dempster, A.P., Laird, N.M., Rubin, D.B.: Maximum likelihood from incomplete data via the EM algorithm. J. R. Stat. Soc. Ser. B (Methodol.) 39(1), 1–38 (1977)MathSciNetMATH

15.

Diebold, F.X.: Comparing predictive accuracy, twenty years later: a personal perspective on the use and abuse of Diebold–Mariano tests. J. Bus. Econ. Stat. 33(1), 1–1 (2015)MathSciNetCrossRef

16.

Diebold, F.X., Mariano, R.S.: Comparing predictive accuracy. J. Bus. Econ. Stat. 20, 134–144 (2012)MathSciNetCrossRef

17.

Dornier, F., Queruel, M.: Caution to the wind. Energy Power Risk Manag. 13(8), 30–32 (2000)

18.

Dufour, F., Elliott, R.: Filtering with discrete state observations. Appl. Math. Optim. 40(2), 259–272 (1999)MathSciNetMATHCrossRef

19.

Elias, R., Wahab, M., Fang, L.: A comparison of regime-switching temperature modeling approaches for applications in weather derivatives. Eur. J. Oper. Res. 232(3), 549–560 (2014)MathSciNetMATHCrossRef

20.

Elliott, R.J., Aggoun, L., Moore, J.B.: Hidden Markov Models: Estimation and Control, vol. 29. Springer, Berlin (1995)MATH

21.

Enders, W., Doan, T.: Estimating a threshold autoregression. In: RATS programming manual 2nd Edition. pp. 159–169 (2014)

22.

Folland, G.: Real Analysis: Modern Techniques and Their Applications Pure and Applied Mathematics. Wiley, New York (1984)MATH

23.

Franses, P.H., Van Dijk, D.: Non-linear Time Series Models in Empirical Finance. Cambridge University Press, Cambridge (2000)CrossRef

24.

Glasserman, P.: Monte Carlo Methods in Financial Engineering, vol. 53. Springer, Berlin (2003)MATHCrossRef

25.

Guo, X.: Information and option pricings. Quant. Finance 1(1), 38–44 (2001)MathSciNetMATHCrossRef

26.

Hamilton, J.D.: A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica 57(2), 357–384 (1989). https://doi.org/10.2307/1912559 MathSciNetMATHCrossRef

27.

Hamilton, J.D.: Analysis of time series subject to changes in regime. J. Econom. 45(1), 39–70 (1990)MathSciNetMATHCrossRef

28.

Hyndman, R.J., Koehler, A.B.: Another look at measures of forecast accuracy. Int. J. Forecast. 22(4), 679–688 (2006)CrossRef

29.

Janczura, J., Weron, R.: http://ideas.repec.org/s/wuu/hscode.html (2011). Accessed 21 Oct 2015

30.

Janczura, J., Weron, R.: Efficient estimation of Markov regime-switching models: an application to electricity spot prices. AStA Adv. Stat. Anal. 96(3), 385–407 (2012)MathSciNetMATHCrossRef

31.

Kallsen, J., Shiryaev, A.N.: The cumulant process and Esscher’s change of measure. Finance Stoch. 6(4), 397–428 (2002)MathSciNetMATHCrossRef

32.

Kim, C.J.: Dynamic linear models with Markov-switching. J. Econom. 60(1), 1–22 (1994). https://doi.org/10.1016/0304-4076(94)90036-1 MathSciNetMATHCrossRef

33.

Mamon, R.S., Elliott, R.J.: Hidden Markov Models in Finance, vol. 104. Springer, Berlin (2007)MATH

34.

Mamon, R.S., Elliott, R.J.: Hidden Markov Models in Finance. Springer, Berlin (2014)MATHCrossRef

35.

Mraoua, M., Bari, D.: Temperature stochastic modeling and weather derivatives pricing: empirical study with Moroccan data. Afr. Stat. 2(1), 22–43 (2007)MathSciNetMATH

36.

Naik, V.: Option valuation and hedging strategies with jumps in the volatility of asset returns. J. Finance 48(5), 1969–1984 (1993)CrossRef

37.

NCDC: National climatic data center, http://www.ncdc.noaa.gov/oa/ncdc.html (2014). Accessed 15 April 2014

38.

Nelson, C.R., Kim, C.J.: State-Space Models with Regime-Switching. MIT Press, Cambridge (1999)

39.

Shen, Y., Fan, K., Siu, T.K.: Option valuation under a double regime-switching model. J. Futures Mark 34(5), 451–478 (2014)CrossRef

40.

Sotomayor, L.R., Cadenillas, A.: Explicit solutions of consumption-investment problems in financial markets with regime switching. Math. Finance Int. J. Math. Stat. Financ. Econ. 19(2), 251–279 (2009)MathSciNetMATH

41.

Swishchuk, A., Cui, K.: Weather derivatives with applications to Canadian data. J. Math. Finance 3, 81–95 (2013)CrossRef

42.

Tong, H.: Threshold models. In: Threshold Models in Non-linear Time Series Analysis. Lecture Notes in Statistics, vol 21. Springer, New York, NY Springer (1983). https://doi.org/10.1007/978-1-4684-7888-4_3

43.

Zapranis, A., Alexandridis, A.: Modelling the temperature time-dependent speed of mean reversion in the context of weather derivatives pricing. Appl. Math. Finance 15(4), 355–386 (2008)MathSciNetMATHCrossRef

Title: A regime switching model for temperature modeling and applications to weather derivatives pricing
Authors: Aysun Türkvatan
Azize Hayfavi
Tolga Omay
Publication date: 16-05-2019
Publisher: Springer Berlin Heidelberg
Published in: Mathematics and Financial Economics / Issue 1/2020
Print ISSN: 1862-9679
Electronic ISSN: 1862-9660
DOI: https://doi.org/10.1007/s11579-019-00242-0

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft"

Springer Professional "Wirtschaft+Technik"

Other articles of this Issue 1/2020

Dual representations for systemic risk measures

Fractional risk process in insurance

The learning premium

Game theoretic valuation of deposit insurance under jump risk: from too small to survive to too big to fail

Optimal portfolio choice: a minimum expected loss approach

Managing inventory with proportional transaction costs