A Quick Guide to Weather Derivatives (pdf) Nov 11 2019 13:08 languageMoneyScience
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Q. What is a weather derivative?
A weather derivative is a risk management product that allows a company to protect itself against adverse weather. Unlike conventional weather insurance where the payout is based on a demonstrated loss (“indemnification”), the payout of a weather derivative is based on a weather index (“parametric”). For example, the index used could be millimetres of rainfall or cumulative temperature using observations from a single weather reference site or a basket of sites.
Weather derivatives are most often used to address the “volume risk” that a company faces. For example, a gas distributor may sell less gas in a mild winter thereby reducing profit. However, weather hedges can also be linked to a commodity price: for example a payout may be linked both to the oil price and weather conditions.
Most weather contracts are over-the-counter (“OTC”) structures tailored specifically to suit the exposure of a particular business.
The first weather derivatives traded in the late 1990s.