Weak vs. Strong Correlations: Bid-Ask Spreads for Weather-Contingent Options
Rene' Carmona, Dario Villani
TL;DR
This paper uses Monte Carlo simulations to price weather-contingent options and analyzes bid-ask spreads based on market correlations, focusing on weather versus natural gas options.
Contribution
It introduces a calibration method for pricing weather options and examines how market correlations influence bid-ask spreads.
Findings
Bid-ask spreads are affected by correlations across markets.
Calibration effectively fits quoted prices.
Analysis provides insights into weather and natural gas option pricing.
Abstract
We price weather-contingent options by use of Monte Carlo simulations. After calibrating the models to fit quoted prices, we analyze bid-ask spreads in terms of correlations across markets. Results are presented for a double-trigger Weather vs. Natural Gas call option.
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Taxonomy
TopicsClimate Change Policy and Economics · Economic and Environmental Valuation · Housing Market and Economics