The pricing, structure, and function of weather‐linked bonds, mortgages, and operating credit

This paper outlines approaches to valuating weather‐linked bonds, mortgages, and operating lines of credit. Using historical data from weather stations in Adrmore, Oklahoma, and Ithaca, New York, indemnities and insurance premiums are computed for specific‐event rainfall insurance. The main contribution of the paper is the development of new and accurate formulae for determining the coupon rates on weather‐linked bonds and the interest rates on weather‐linked mortgages and lines of credit. The empirical aspects of the paper indicate that linking weather risk to debt may be very costly if the risks are common, but the risk premiums on rare or low‐frequency weather risks can be very manageable.