An extension of spatial dependence models for estimating short-term temperature portfolio risk.
Temperature risk is any adverse financial outcome caused by temperature outcomes. The Chicago Mercantile Exchange lists a series of financial products which link payments to temperature outcomes, and therefore these products can help institutions manage temperature risk. Financial institutions can also hold a portfolio of these products as counterparty to the institutions facing temperature risk. Here we take an actuarial perspective and model the daily temperatures directly. These models are then used to simulate distributions of future temperature outcomes. The model for daily temperature is a spatial ARMA-EGARCH statistical model which incorporates dependence in both time and space, and also volatility modeling. Simulations from this model are used to build up distributions of temperature outcomes, and we demonstrate how actuarial risk measures of the portfolio can then be estimated from these distributions.ial dependence models for estimating short-term temperature portfolio risk