Affiliations: Department of Mathematical Sciences, University of Cincinnati, Cincinnati, OH, USA. E-mail: stojans@ucmail.uc.edu | Center for Financial Engineering, Soochow University, Suzhou, Jiangsu, China | Department of Mathematical Sciences, Xian Jiaotong-Liverpool University, Suzhou, Jiangsu, China. E-mail: Ahmet.Goncu@xjtlu.edu.cn | Center for Economics and Econometrics, Bogazici University, Istanbul, Turkey
Note: [] Corresponding author: Srdjan Stojanovic, Department of Mathematical Sciences, University of Cincinnati, Cincinnati, OH 45221, USA. E-mail: stojans@suda.edu.cn
Abstract: Pricing formulas for components of a portfolio of temperature-based weather derivatives, as well as the corresponding hedging formula, are derived using the recent general theory of neutral and indifference pricing and hedging in incomplete markets. The derived pricing formulas have the flexibility to account for the total exposure, i.e., for the number of weather derivatives contracts held. In particular, we obtain a structural form for the market price of risk (the risk premium).
Keywords: Neutral pricing, indifference pricing, portfolios of weather derivatives, hedging, cumulative average temperatures
