Weather forecasting with market prices of weather futures

ABSTRACT Many companies depend on weather conditions, so they require reliable weather forecasts for production planning or risk hedging. In this paper, we propose a new way of obtaining weather forecasts by exploiting the forward-looking information included in the market prices of weather derivatives traded at the Chicago Mercantile Exchange (CME). For this purpose, the CME futures prices of two monthly temperature indexes relevant for the energy sector are compared with index forecasts derived from meteorological temperature forecasts. It turns out that the market prices generally outperform the meteorological forecasts in predicting the outcome of the monthly index. Hence, companies whose profit strongly depends on these indexes, such as energy companies, can profit from this additional information source about future weather.