Science Heritage Journal | Galeri Warisan Sains (GWS)

Weather derivatives pricing is one of the central issues in the study of this type of financial product, and there is no uniform methodology. To price the temperature option with Shanghai temperature as the underlying and explore how to improve the accuracy of option pricing, firstly, the time-varying O-U model is combined with Monte Carlo simulation to obtain the Shanghai-based temperature option pricing, and then Shanghai and its neighboring Dongtai, Quxian, and Dinghai are selected to constitute an option portfolio and priced using the same method. The results are obtained: 1) the predicted price of each unit of Shanghai temperature option is 1732.33 yuan, and the actual price is 1557.84 yuan, with a relative error of 9.1%; 2) the predicted price of each unit of option portfolio is 1598.12 yuan, and the actual price is 1500.72 yuan, with a relative error of 6.5%; and 3) the same pricing steps are repeated several times, with a very robust relative error. It can be seen that the pricing method has stability and higher prediction accuracy and can be used in practice. At the same time, pricing after selecting multiple cities to form a weather derivative portfolio has higher accuracy i.e. less risk than pricing only for a single city.