Single Factor Stochastic Models with Seasonality Applied to Underlying Weather Derivatives Variables

The authors employ single-factor models to estimate daily temperature variations for the valuation of weather derivatives. Classical financial models are adapted to fit temperature seasonality to a time series. As an example, Monte Carlo simulations of heating and cooling degree-days are used as the underlying for weather derivatives that reference temperatures in regions of Spain. The article also discusses potential applications to hedging energy-related risks