Pricing summer day options by good-deal bounds

Abstract

Despite the worldwide popularity of CDD- and HDD-type weather derivatives based on temperature, a different class of weather derivatives, so-called summer day options, is more popular in Japan; the payoffs are determined by the number of summer days (i.e., the days whose average temperature is above 25 °C) during the contract period. In this paper, we price such summer day options by the good-deal bounds of Cochrane and Saa-Requejo [Cochrane, J.H., and J. Saa-Requejo, 2000, Beyond Arbitrage: Good-Deal Asset Price Bounds in Incomplete Markets, Journal of Political Economy 108, 79–119.], using temperature data for Tokyo.