Marginal value approach to pricing temperature options and its empirical example of daily temperatures in Nagoya
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This paper focuses on temperature options pricing using the marginal substitution value approach proposed by Davis. We first extend a utility function dealt with in Davis's work to the functions of "HARA" type which are well-known as a general class of utility functions in theoretical economics. The extension allows us to analyse the sensitivity of "temperature options" price to a riskaversion coefficient. In this framework, we next evaluate temperature option price contract on accumulated cooling degree days (CDDs) for an electric power generator. As an illustrative example, a time series model of daily air temperature at Nagoya city in Japan is estimated and on the basis of the model and our pricing formula, the temperature option prices for CDDs in summer are calculated numerically. The result verifies that the temperature put option has the property of an insurance product for the purchaser.
Oikonomika 44(2), 1-16, 2007-11
Nagoya City University