Implied Market Price ofWeather Risk

Weather inuences our daily lives and choices and has an enormous impact on corporate revenues andearnings. Weather derivatives dier from most derivatives in that the underlying weather cannot be tradedand their market is relatively illiquid. The weather derivative market is therefore incomplete. This paperimplements a pricing methodology for weather derivatives that can increase the precision of measuringweather risk. We have applied continous autoregressive models (CAR) with seasonal variation to modelthe temperature in Berlin and with that to get the explicite nature of non-arbitrage prices for temperaturederivatives. We infer the implied market price from Berlin cumulative monthly temperature futures thatare traded at the Chicago Mercantile Exchange (CME), which is an important parameter of the associatedequivalent martingale measures used to price and hedge weather future/options in the market. We proposeto study the market price of risk, not only as a piecewise constant linear function, but also as a timedependent object. In all of the previous cases, we found that the market price of weather risk is dierentfrom zero and shows a seasonal structure. With the extract information we price other exotic options, suchas cooling/heating degree day temperatures and non-standard maturity contracts.