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Int. J. Financial Stud. 2017, 5(4), 23; doi:10.3390/ijfs5040023

A Dynamic Programming Approach for Pricing Weather Derivatives under Issuer Default Risk

1,2,†,‡
and
1,‡,*
1
Ladislaus von Bortkiewicz Chair of Statistics, School of Business and Economics, Humboldt-Universität zu Berlin, Unter den Linden 6, 10099 Berlin, Germany
2
Sim Kee Boon Institute for Financial Economics, Singapore Management University, 90 Stamford Road, 6th Level, School of Economics, Singapore 178903, Singapore
Current address: Ladislaus von Bortkiewicz Chair of Statistics, School of Business and Economics, Humboldt-Universität zu Berlin, Unter den Linden 6, 10099 Berlin, Germany.
These authors contributed equally to this work.
*
Author to whom correspondence should be addressed.
Academic Editor: Dennis Belomestny
Received: 16 September 2017 / Revised: 15 October 2017 / Accepted: 16 October 2017 / Published: 20 October 2017
(This article belongs to the Special Issue Recent Developments in Numerical Methods for Option Pricing)
View Full-Text   |   Download PDF [305 KB, uploaded 25 October 2017]   |  

Abstract

Weather derivatives are contingent claims with payoff based on a pre-specified weather index. Firms exposed to weather risk can transfer it to financial markets via weather derivatives. We develop a utility-based model for pricing baskets of weather derivatives under default risk on the issuer side in over-the-counter markets. In our model, agents maximise the expected utility of their terminal wealth, while they dynamically rebalance their weather portfolios over a finite investment horizon. Using dynamic programming approach, we obtain semi-closed forms for the equilibrium prices of weather derivatives and for the optimal strategies of the agents. We give an example on how to price rainfall derivatives on selected stations in China in the universe of a financial investor and a weather exposed crop insurer. View Full-Text
Keywords: dynamic programming; pricing; risk management dynamic programming; pricing; risk management
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Härdle, W.K.; Osipenko, M. A Dynamic Programming Approach for Pricing Weather Derivatives under Issuer Default Risk. Int. J. Financial Stud. 2017, 5, 23.

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