What is ‘Heating Degree Day – HDD’
The number of degrees that a day’s average temperature is below 65oFahrenheit (18o Celsius), the temperature below which buildings need to be heated. The price of weather derivatives traded in the winter is based on an index made up of monthly HDD values. The settlement price for a weather futures contract is calculated by summing HDD values for a month and multiplying that sum by $20.
Explaining ‘Heating Degree Day – HDD’
To calculate HDD, take the average of a day’s high and low temperatures and subtract from 65. For example, if the day’s average temperature is 50o F, its HDD is 15. If every day in a 30-day month had an average temperature of 50o F, the month’s HDD value would be 450 (15 x 30). The nominal settlement value for this month’s weather derivative contract would therefore be $9,000 (450 x $20).
Further Reading
- The degree-day method to estimate the residential heating natural gas consumption in Turkey: a case study – www.sciencedirect.com [PDF]
- Modeling and forecasting cumulative average temperature and heating degree day indices for weather derivative pricing – link.springer.com [PDF]
- Agricultural applications of weather derivatives – clutejournals.com [PDF]
- Modeling and forecasting CAT and HDD indices for weather derivative pricing – link.springer.com [PDF]
- Insurance against weather risk: Use of heating degree-days from non-local stations for weather derivatives – link.springer.com [PDF]
- WEATHER DERIVATIVES AS TOOLS FOR FINANCIAL MANAGEMENT OF NATURAL DISASTER RISK – search.proquest.com [PDF]
- An Explicit Distribution to Model the Proportion of Heating Degree Day and Cooling Degree Day – www.tandfonline.com [PDF]
- Using weather derivatives to manage financial risk in deregulated electricity markets. – elibrary.ru [PDF]
- Daily air temperature and electricity load in Spain – journals.ametsoc.org [PDF]
- Investment analysis of gas-turbine combined heat and power systems for commercial buildings under different climatic and market scenarios – www.sciencedirect.com [PDF]
