Indifference pricing of weather derivatives

Abstract

Weather derivatives are difficult to price due to the nontradability of weather and the absence of liquid secondary markets for these contracts. We use the concept of indifference pricing to develop a model for calculating the willingness to pay for weather insurance. Compared with other approaches, indifference pricing is less ambitious since it does not attempt to predict a transacted market price. The application of indifference pricing in the case of German crop producers shows that their willingness to pay for weather insurance depends on the production program and varies regionally. This suggests the development of tailored insurance products.