Arbeitspapier

Spatial risk premium on weather derivatives and hedging weather exposure in electricity

Due to dependency of energy demand on temperature, weather derivatives enable the effective hedging of temperature related fluctuations. However, temperature varies in space and time and therefore the contingent weather derivatives also vary. The spatial derivative price distribution involves a risk premium. We examine functional principal components of temperature variation for this spatial risk premium. We employ a pricing model for temperature derivatives based on dynamics modelled via a vectorial Ornstein-Uhlenbeck process with seasonal variation. We use an analytical expression for the risk premia depending on variation curves of temperature in the measurement period. The dependence is exploited by a functional principal component analysis of the curves. We compute risk premia on cumulative average temperature futures for locations traded on CME and fit to it a geographically weighted regression on functional principal component scores. It allows us to predict risk premia for nontraded locations and to adopt, on this basis, a hedging strategy, which we illustrate in the example of Leipzig.

Language
Englisch

Bibliographic citation
Series: SFB 649 Discussion Paper ; No. 2011-013

Classification
Wirtschaft
Econometrics
Multiple or Simultaneous Equation Models: Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
Subject
risk premium
weather derivatives
Ornstein-Uhlenbeck process
functional principal components
geographically weighted regression
Wetter
Risikoprämie
Region
Elementarschadenversicherung
Finanzderivat
Optionspreistheorie
Theorie

Event
Geistige Schöpfung
(who)
Härdle, Wolfgang Karl
Osipenko, Maria
Event
Veröffentlichung
(who)
Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk
(where)
Berlin
(when)
2011

Handle
Last update
10.03.2025, 11:42 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Härdle, Wolfgang Karl
  • Osipenko, Maria
  • Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk

Time of origin

  • 2011

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