140 Valuation and Risk Management of Weather Derivatives: The Application of CME Rainfall Index Binary Contracts Analysis (i): The MPR for different dates from January 3 to March 31; for same option (call or put) and same strike price; in the same year (2005 or 2006) In Figure 6, the dotted line represents March 1, which divides the time into before the contract period and during the contract period. We find that the MPR usually becomes stable after entering the contract period (March 1) and keeps moving around the level of the final settlement. The MPR generally increases as time passes. It is a reasonable explanation that the investors could obtain more information about the monthly rainfall index when approaching the contract period, which makes their estimations more accurate. Analysis (ii): The MPR for different strike prices for the same option (call or put) on the same date; from January 3 to March 31; in the same year (2005 or 2006) We compare the MPR between different strike prices K on the same date in Figure 6. We find that when entering the contract period, the MPR is larger with a greater strike price in put options, but smaller in call options, which means approaching the theoretical expected rainfall index. It is consistent with the result of analysis (i), in which the investors receive more information as time passes. Analysis (iii): The relationship of the MPR between call and put options with close strike price in 2006 We compare the MPR between the call with K = 179 and the put with K = 173 in 2006. Based on Figure 6, we find that the MPR of the call option is greatly greater than the put option, which implies that the investors of the former need a larger risk premium than the latter. Since the humidity in Des Moines can be greater in spring and summer due to its humid continental climate, the precipitation peaks in warmer months. There will be a larger demand of risk management against a high magnitude, which is consistent with the larger MPR in call option. Analysis (iv): The relationship of the MPR between put options with close strike prices in different years As shown in Figure 6, before entering the contract period, the MPR of the put option in 2006 is greater than that in 2005, which may be due to the extremely destructive Hurricane Katrina happened in August 2005. According to the U.S. National Hurricane Center (NHC), Hurricane Katrina has caused $125 billion in losses in the U.S. Since then, many investors have poured into the weather risk market, which explains the MPR gap in put options between 2005 and 2006. There may be doubts as to why the MPR in 2005 is greater than in 2006 after entering the contract. As we discuss in Analysis (i) and (ii), the investors are able to obtain more
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