New weather indices for China: based on DCC-GARCH and GRU models

Abstract

Because China is a major production and operations hub, it is at the centre of the world's supply chain. However, as weather can significantly affect supply chain operations, to better hedge risk, weather derivatives need to be introduced to Chinese financial markets to secure multinational supply chains. Using historical records over a decade, three models are proposed and new weather indices are created and improved using DCC-GARCH and GRU models. A simulation test from 2008 to 2017 data proved the indices to be feasible and stable, and matched 92% of the risk across two dimensions: 1) the changing Chinese weather data; 2) a connection with US weather index.