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A Lévy-driven rainfall model with applications to futures pricing

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  • Ragnhild Noven
  • Almut Veraart
  • Axel Gandy

Abstract

We propose a parsimonious stochastic model for characterising the distributional and temporal properties of rainfall. The model is based on an integrated Ornstein–Uhlenbeck process driven by the Hougaard Lévy process. We derive properties of this process and propose an extended model which generalises the Ornstein–Uhlenbeck process to the class of continuous-time ARMA processes. The model is illustrated by fitting it to empirical rainfall data on both daily and hourly time scales. It is shown that the model is sufficiently flexible to capture important features of the rainfall process across locations and time scales. Finally, we study an application to the pricing of rainfall derivatives which introduces the market price of risk via the Esscher transform. We first give a result specifying the risk-neutral expectation of a general moving average process. Then we illustrate the pricing method by calculating futures prices based on empirical daily rainfall data, where the rainfall process is specified by our model. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Ragnhild Noven & Almut Veraart & Axel Gandy, 2015. "A Lévy-driven rainfall model with applications to futures pricing," AStA Advances in Statistical Analysis, Springer;German Statistical Society, vol. 99(4), pages 403-432, October.
    • Handle: RePEc:spr:alstar:v:99:y:2015:i:4:p:403-432
    DOI: 10.1007/s10182-015-0246-8
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    References listed on IDEAS

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    1. Wolfgang Karl Härdle & Brenda López Cabrera, 2012. "The Implied Market Price of Weather Risk," Applied Mathematical Finance, Taylor & Francis Journals, vol. 19(1), pages 59-95, February.
    2. Brockwell, Peter J. & Lindner, Alexander, 2009. "Existence and uniqueness of stationary Lévy-driven CARMA processes," Stochastic Processes and their Applications, Elsevier, vol. 119(8), pages 2660-2681, August.
    3. López Cabrera, Brenda & Odening, Martin & Ritter, Matthias, 2013. "Pricing rainfall futures at the CME," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4286-4298.
    4. Peter Brockwell & Alexander Lindner, 2013. "Integration of CARMA processes and spot volatility modelling," Journal of Time Series Analysis, Wiley Blackwell, vol. 34(2), pages 156-167, March.
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    7. Marco Frittelli, 2000. "The Minimal Entropy Martingale Measure and the Valuation Problem in Incomplete Markets," Mathematical Finance, Wiley Blackwell, vol. 10(1), pages 39-52, January.
    8. Gunther Leobacher & Philip Ngare, 2011. "On Modelling and Pricing Rainfall Derivatives with Seasonality," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(1), pages 71-91.
    9. René Carmona & Pavel Diko, 2005. "Pricing Precipitation Based Derivatives," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(07), pages 959-988.
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    Cited by:

    1. Markus Hess, 2016. "Modeling And Pricing Precipitation Derivatives Under Weather Forecasts," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(07), pages 1-29, November.
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