Pricing the weather

Pricing weather derivatives is different from valuing other derivatives contracts – actuarial methods play a greater role. Steve Jewson looks at the varied approaches available

How should weather derivatives be priced? And how should the risk in weather derivative portfolios be estimated? Should we be using a version of Black-Scholes, or averages of historical weather, or weather forecasts? And what about global warming?

The recent influx of banks and hedge funds into the weather market means that increasing numbers of quantitative analysts are having to grapple with these questions. The methods used for pricing weather derivatives are, however, somewhat different from