Model Comparison for Temperature-Based Weather Derivatives in Mainland China

Abstract:

In this paper, we provide a comparison of two models of temperature-based weather derivatives. The Alaton et al. model (2002) and the continuous-time autoregressive (CAR) model of Benth et al. (2007) are applied to temperature data from twelve cities in China. The objective is to determine which is the better model for temperature derivative modeling in Chinese cities. We found the CAR model to be more accurate in terms of normality of residuals and smaller relative errors. However, the shortcomings of both the Alaton et al. model and the CAR model are revealed in this study as well.