weather derivative
figure 1 - a weather derivative table quoting prices of may 2005 contracts. source: chicago mercantile exchange weather - i™ .
a weather derivative is a futures contract - - or options on that futures contract - - where the underlying commodity is a weather index .
keep up with the latest weather derivatives and weather risk management news on our blog .
a weather derivative is a financial instruments which are used to help a company or organisation reduce the risks associated with adverse or unusual weather conditions. they work just like most other derivative contracts except the underlying asset (which is a weather condition such as rainfall, temperature or snowfall) has no value with which to price the derivative contract .
covers the meteorological, statistical, financial and mathematical issues that arise in the pricing and risk management of weather derivatives. written by consultants who work within the weather derivative industry, this book is packed with practical information and theoretical insight into the world of weather derivative pricing .
a derivative is a financial contract that gets its value from an underlying asset. options offer one type of common derivative. read answer > >
a. zapranis and a. alexandridis, “modelling and forecasting cat and hdd indices for weather derivative pricing, ” in
weather derivatives - modeling and pricing weather - related risk | antonis alexandridis k. | springer
a selection of articles and research papers on weather derivatives and weather risk pricing and structuring .
a weather derivative is a financial instrument used by companies or individuals to hedge against the risk of weather - related losses. the seller of a weather derivative agrees to bear the risk of disasters in return for a premium. if no damages occur before the expiration of the contract, the seller will make a profit. in the event of unexpected or adverse weather, the buyer of the derivative claims the agreed amount .
originally published in 2005, weather derivative valuation covers all the meteorological, statistical, financial and mathematical issues that arise in the pricing and risk management of weather derivatives. there are chapters on meteorological data and data cleaning, the modelling and pricing of single weather derivatives, the modelling and valuation of portfolios, the use of weather and seasonal forecasts in the pricing of weather derivatives, arbitrage pricing for weather derivatives, risk management, and the modelling of temperature, wind and precipitation. specific issues covered in detail include the analysis of uncertainty in weather derivative pricing, time - series modelling of daily temperatures, the creation and use of probabilistic meteorological forecasts and the derivation of the weather derivative version of the black - scholes equation of mathematical finance. written by consultants who work within the weather derivative industry, this book is packed with practical information and theoretical insight into the world of weather derivative pricing .
originally published in 2005, weather derivative valuation covers all the meteorological, statistical, financial and mathematical issues that arise in the pricing and risk management of weather derivatives. there are chapters on meteorological data and data cleaning, the modelling and pricing of single weather derivatives, the modelling and valuation of portfolios, the use of weather and seasonal forecasts in the pricing of weather derivatives, arbitrage pricing for weather derivatives, risk management, and the modelling of temperature, wind and precipitation. specific issues covered in detail include the analysis of uncertainty in weather derivative pricing, time - series modelling of daily temperatures, the creation and use of probabilistic meteorological forecasts and the derivation of the weather derivative version of the black - scholes equation of mathematical finance. written by consultants who work within the weather derivative industry, this book is packed with practical information and theoretical insight into the world of weather derivative pricing. show more
weather derivatives are financial instruments that can be used for risk management purposes to hedge against losses due to adverse, unpredictable weather. in contrast to other derivative products, the underlying asset - such as frost, rain, temperature and wind - has no direct value with respect to the price of the weather derivative .
m. cao and j. wei, “weather derivatives valuation and market price of weather risk, ”
s. d. campbell and f. x. diebold, “weather forecasting for weather derivatives, ”
m. cao and j. wei, “pricing the weather. risk weather risk special report, ”
the party that sells a weather derivative bears this risk for a premium and stands to earn a profit if the weather remains relatively stable, predictable or normal. if the weather does turn bad, then the party that purchases the derivative claims the agreed upon amount. as one would expect, temperature is the most commonly used underlying weather factor, 18 degrees celsius (65 degrees fahrenheit) is a standard baseline from which deviations are measured, but any other measurable weather - related event can be used as an underlying factor for a weather derivative .
a spatial approach to addressing weather derivative basis risk: a drought insurance example nick d. paulson and chad e. hart jul 2006
a credit derivative is a financial asset in the form of a privately ...
nobel weather associates helps companies protect against the negative impact that weather can have on their expenses and revenue .
speedwell weather is a uk - based firm that provides world - wide weather data, forecasts, software and consulting services to the energy and weather derivative markets. the firm is a recognized leader in the weather markets, with a strong following in europe and a growing presence in other parts of the globe .
weather derivatives are used to hedge the risks of inclement weather conditions. they are measurable and essentially triggered by actual weather conditions making them a predictable form of risk management .
in 1997, the first over - the - counter (otc) weather derivative trade took place, and the field of weather risk management was born. according to valerie cooper, former executive director of the weather risk management association, an $ 8 billion weather derivatives industry developed within a few years of its inception .
current users of weather futures are primarily companies in energy - related businesses. however, there is growing awareness and signs of potential growth in the trading of weather futures among agricultural firms, restaurants and companies involved in tourism and travel. many otc weather derivative traders also trade cme weather futures for purposes of hedging their otc transactions .
even in our advanced, technology - based society, we still live largely at the mercy of the weather. it influences our daily lives and has an enormous impact on corporate revenues and earnings. until recently, there were very few financial tools offering companies protection against weather - related risks. however, the inception of the weather derivative —making weather a tradeable commodity—has changed all this. here we look at how the weather derivative was created, how it differs from insurance and how it works as a financial instrument .
investors who sell weather derivatives agree to take on the risk for a premium. investors will profit from these transactions if weather conditions remain normal. if the weather changes unexpectedly, the company that bought the derivative collects an agreed - upon amount. to trade these products market participants will use weather forecasts to predict how the weather conditions will affect the current and future market. weather market players are from a variety of industries and other participants include hedge funds, institutional firms, and brokers .
weather derivative is a new risk management tool which can be widely used in the financial market to avoid the impact of bad weather effects and control the weather risks. the first weather derivative was introduced in the us in 1997 and the size of the market now exceeds 8 billion dollars. weather derivatives are different from traditional financial derivatives as their underlying asset such as temperature, humidity, and precipitation, which cannot be traded in the market, so ordinary pricing models such as black and scholes formula is not applicable in pricing weather derivatives. as a consequence, the valuation of weather derivatives is generally carried out in a lot of paperwork. weather derivatives can be based on any meteorological index, such as temperature, rain, wind, and snow, while the most commonly used weather variable is the temperature .
heating degree day and cooling degree day derivative contracts are among the most common types of weather derivatives. the chicago mercantile exchange provides a platform for buyers and sellers of weather derivatives and offer temperature, rainfall, snowfall, frost and hurricane derivatives contracts .
china’s climate varies drastically because the country is large, and weather events affect the profits of many of its industries. as a new risk management instrument, weather derivative market is developing rapidly. so the introduction of weather derivatives can bring significant benefits to various weather - affected industries in china. as weather is not a tradable asset, it is a relatively complicated task to make a “fair” pricing model for them. in order to enable the weather derivative market and bring significant benefits to various weather - affected industries in china, it is essential for the new market, especially in china, that a transparent and reliable approach to pricing is put in place so that the participants can feel secure in their transactions .
protection against undesirable weather events, like, for instance, hurricanes and droughts, has been offered by insurance companies. in the recent decades, the securitization of such weather insurances has taken place, and nowadays one can trade weather derivative contracts at the chicago mercantile exchange (cme), or more specialized weather contracts in the otc market. at the cme, one finds derivatives written on temperature and snowfall indices, measured at different locations worldwide. the market for weather derivatives is emerging and gaining importance as a tool for hedging weather risk .
stephen jewson works for a financial consultancy where he manages a group that produces commercial software and meteorological data for the weather derivative industry. he has published a large number of articles in the fields of fundamental climate research, applied meteorology and weather derivatives. show more
as the underlying asset of the weather derivative is non - tradeable these instruments cannot be priced in the same way as more traditional derivatives. there is no standard model for valuing weather derivatives similar to the widely used black - scholes formula that is used to price many equity options and similar derivatives. as such they are more prone to modelling risk than other types of derivative products .
weather is determined by an independent historical weather provider. julia receives money if there is any rain (more than zero) on her wedding day !
weather derivatives, developed in the 1990s, fill an unmet need in the economy. the weather impacts roughly 20% of the u. s. economy. agriculture, energy, travel, and construction are examples of industries in which weather plays an especially important role. but unexpected weather rarely results in price adjustments which entirely make up for lost revenue. weather derivatives allow companies to hedge against the possibility of weather that might adversely affect their business .
in 1997, weather derivatives began trading over - the - counter (otc), and within a few years, they had become an $ 8 billion industry. the chicago mercantile exchange (cme) lists weather derivative contracts for a few dozen cities, the majority of them in the u. s. some hedge funds treat weather derivatives as an investment class. investors who like weather derivatives appreciate their low correlation with traditional markets .
asc 815 - 10 notes that it
defines derivative instrument, addresses the pervasive scope of this topic, and specifies the primary accounting for derivative instruments within this topic' s scope .
it further notes the following information regarding the entire 815 topic :
learn about weather derivatives, a financial instrument that makes temperature a tradable commodity .
analysts look at historical weather patterns - - temperature, rainfall and other things - - develop averages, and quantify the risk that weather will deviate from the average .
weather derivatives are different from insurance, because they' re linked to common weather events, like dry seasons, or a warm autumn, that affect particular businesses .
asc 815 - 45 provides guidance on the financial accounting and reporting for weather derivatives .
a derivative security in which an investor hedges against the future state of the weather. for example, two investors may enter a weather derivative, where one investor pays the other if rainfall in a given place over a given period of time is above a certain amount. likewise, the other investor pays if the rainfall is below the agreed - upon amount. one of the most common weather derivatives is a weather future, in which the buyer is required to pay the seller $ 20 for each day in a given month that the daily temperature is below 65 degrees (a heating degree day) or above 65 degrees (a cooling degree day), depending on the nature of the contract. a weather future allows a business to hedge against potential losses resulting from an unexpected change in weather. energy companies are some of the most common sellers of weather derivatives .
examples of their use could be a ski resort who hedge against the risk that snowfall is too light to allow them to open their slopes (so they buy a snowfall derivative which pays out if snowfall is below a pre defined level), a farmer may buy a weather derivative to hedge against the risks of frost or drought impacting their crops and a power company may hedge against the risks that the weather is warmer than average in winter and their customers don' t use their heating as much. effectively all these examples provide the company buying the derivative wit an opportunity to smooth their earnings over a period of adverse weather which would usually have affected them financially .
​weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to minimize risk associated with adverse or unexpected weather conditions. just as traditional contingent claims, a weather derivative has an underlying measure, such as: rainfall, wind, snow or temperature. nearly $ 1 trillion of the u. s. economy is directly exposed to weather - related risk. more precisely, almost 30% of the u. s. economy and 70% of u. s. companies are affected by weather. the purpose of this monograph is to conduct an in - depth analysis of financial products that are traded in the weather market. presenting a pricing and modeling approach for weather derivatives written on various underlying weather variables will help students, researchers, and industry professionals accurately price weather derivatives, and will provide strategies for effectively hedging against weather - related risk. this book will link the mathematical aspects of the modeling procedure of weather variables to the financial markets and the pricing of weather derivatives. very little has been published in the area of weather risk, and this volume will appeal to graduate - level students and researchers studying financial mathematics, risk management, or energy finance, in addition to investors and professionals within the financial services industry. ​
a. zapranis and a. alexandridis, “wavelet analysis and weather derivatives pricing, ” in
j. svec and m. stevenson, “modelling and forecasting temperature based weather derivatives, ”
a. swishchuk and k. cui, “weather derivatives with applications to canadian data, ”
doing something about weather: weather derivatives have helped companies control financial risk for nearly a decade. now that they' re trading on a mercantile exchange, sales are really taking off
e. platen and j. west, “a fair pricing approach to weather derivatives, ”
in fact, it is more important that the model is statistically significant for weather derivative pricing. we compare the predicted values obtained by our stochastic model with 100, 000 simulations to the actual observations for zhengzhou over year 2013 (see figure
mda earthsat is the premier source of specialized weather products for global weather risk analysis. users of these products include such varied industries as energy, food, retail, insurance, banking, and government. our products appeal to anyone who must manage and minimize their weather risk .
learn why most exchange - traded funds (etfs) are not considered derivative securities and the special circumstances when this... read answer > >
swiss re announced that it has entered into a weather derivative contract with the international development association (ida), the arm of the world bank that helps the world' s poorest countries. under the terms of the contract, swiss re will pay out up to usd 5 million in the event that malawi' s farmers suffer from a drought - related shortfall in maize production. with this transaction, the ida backs its first - ever weather derivative contract with the government of malawi .
a broad range of weather derivative products are available including options, futures, forwards and swaps. most are traded over - the - counter (otc) although there are some traded electronically on indexes like the chicago merchantile exchange (cme). the cme offers weather derivative products that “offers trading opportunities related to temperatures, snowfall, frost and hurricanes. the products are based on a range of weather conditions in more than 47 cities in the united states, europe, canada, australia and asia, with the hurricane products geared to nine us regions. ” (cme group 2011) [ 1 ]
this weather derivative contract is just one instrument as part of a world bank effort to deliver customized financial solutions and help members plan efficient responses to catastrophic events. the use of weather derivatives are most effective as part of a broader risk management strategy ,
said gloria grandolini, director of the world bank treasury' s banking and debt management department .
weather derivatives are usually structured as swaps, futures, and options based on different underlying weather indexes. some commonly used indices are hdd, cdd, precipitation, wind, and snowfall. for the sake of clarity, we focus our analysis on derivative products whose underlying is the level of cumulated daily temperatures over a given period, the hdd and cdd .
international business machines corp. (ibm) subsidiary the weather company will move its headquarters to atlanta .
h. geman and m. - p. leonardi, “alternative approaches to weather derivatives pricing, ”
m. moreno, “riding the temp, ” weather derivatives, fow special supplement, december 2000 .
insurance is still required to protect against major weather events, like tornadoes, hurricanes, and floods .
nobel weather associates uses patented risk management tools and internal company data to manage the affect that weather has on your cash flows. the program has been proven throughout the united states. regardless of your exposure, nobel weather’s strategies will be tailored to meet the specific needs, circumstances and risk tolerance of each client .
in 2008, volume skyrocketed with the launching of otc weather auctions [ 3 ]. not only has temperature - based weather volume grown, but other weather products have also seen success. business in the cme group hurricane products - now in their second year of trading - has increased dramatically. also, two new online exchanges - stormexchange and weatherbill - have driven the weather derivatives market from mainly energy traders to a whole new set of end - users. both firms have been successful in speaking to end - user traders that are affected by day - to - day weather conditions. these firms have been successful in educating and monatizing their weather risk and structuring over - the - counter weather deals that are customized to their needs .
getting a
weather waiver
when a storm threatens can save your trip – and your travel budget .
f. dornier and m. queruel, “caution to the wind. weather risk special report, ” in
in 1999, the chicago mercantile exchange (cme) took weather derivatives a step further and introduced exchange - traded weather futures and options on futures—the first products of their kind. otc weather derivatives are privately negotiated, individualized agreements made between two parties. but cme weather futures and options on futures are standardized contracts traded publicly on the open market in an electronic auction type of environment, with continuous negotiation of prices and complete price transparency .
swiss re has pioneered weather risk transfer instruments in developing countries, starting in india in 2004 with a programme reaching over 350 000 smallholder farmers. in the meantime, the company has become a leading solution provider in weather and weather contingent commodity price structures with a share of more than 30% in the worldwide weather risk markets. under its climate adaptation and public sector business development programmes, the company fosters the use of modern risk management instruments, such as weather derivatives and insurance - linked securities, to the benefit of non - oecd countries .
companies whose business depends on the weather, such as hydro - electric businesses or those who manage sporting events, might use weather derivatives as part of a risk - management strategy. farmers may use weather derivatives to hedge against a poor harvest caused by too much or too little rain, sudden temperature swings, or destructive winds .
to learn more about how you can change the way weather impacts you call (781) 783 - 3207 .
p. alaton, b. djehiche, and d. stillberger, “on modelling and pricing weather derivatives, ”
weather derivatives are financial instruments that can be used by organizations or individuals as part of a weather risk management strategy to reduce risk associated with adverse or unexpected weather conditions. farmers can use weather derivatives to hedge against poor harvests caused by drought or frost; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (hdd) or cooling degree days (cdd) contracts to smooth earnings .
in this study, a unified approach to pricing is established for the weather derivative marketplace, and we mainly worked on a stochastic modeling to describe the behavior of the temperature choosing as underlying for the hdd call weather derivative. through taking zhengzhou, for example, we establish a stochastic model by the 62 - year historical temperatures in zhengzhou and use the monte carlo method for the hdd call pricing. the model describing the stochastic behavior of the temperature is validated on the basis of temperatures observed during year 2013. as shown by the monthly evolved relative errors, the proposed mean - reverting ornstein - uhlenbeck model can reasonably describe daily temperature data of zhengzhou in the aspects of the mean, volatility, and mean reverting speed. therefore, the mean - reverting ornstein - uhlenbeck model, on the basis of 62 year of data of temperature, in zhengzhou, enabled us to simulate a temperature weather derivative contract .
f. perez - gonzales and h. yun, “risk management and firm value: evidence from weather derivatives, ”
f. e. benth and j. šaltytė benth, “the volatility of temperature and pricing of weather derivatives, ”
m. moreno and d. bari, “temperature stochastic modelling and weather derivatives pricing: empirical study with moroccan data, ”
m. mraoua and d. bari, “temperature stochastic modeling and weather derivatives pricing: empirical study with moroccan data, ”
in general, weather derivatives cover low - risk, high - probability events. weather insurance, on the other hand, typically covers high - risk, low - probability events, as defined in a highly customized policy. for example, a company might use a weather derivative to hedge against a winter forecasters think will be 5° f warmer than the historical average (a low - risk, high - probability event). in this case, the company knows its revenues would be affected by that kind of weather. the same company would also most likely purchase an insurance policy for protection against damage caused by a flood or hurricane (high - risk, low - probability events) .
weather derivatives are similar to but different from insurance. insurance covers low - probability, catastrophic weather events such as hurricanes, earthquakes, and tornados. in contrast, derivatives cover higher - probability events such as a dryer - than - expected summer .
corporations use weather derivatives to hedge their risk that bad weather will cause a financial loss. for a cereal company, bad weather might be a drought, which would cause wheat prices to go up. for a home heating company, it could be warm days in november, which could lower demand for home heating oil. and for an amusement park it could be rain .
in order to avoid excessive payouts on the contract due to extreme weather, the options often come with the maximum payoff. suppose
as a result of the affect of normal variations and extreme or catastrophic events of weather and climate, a growing number of businesses and government entities are seeking out methods to manage their exposure to weather risk, which include the use of derivatives, insurance products and changes in their operations. this course provides a comprehensive and technical treatment of the valuation and risk management of weather derivatives .
one climate index for weather derivative is known as heating degree days or hdd. under hdd contracts, each day the daily mean temperature falls below a predetermined reference point over a specified period, the amount of the departure is recorded and added to a cumulative count. the final figure determines whether the seller pays out or receives payment .
the weather derivative contract with the world bank is a prime example of an ex - ante disaster risk management strategy designed to mitigate the financial impact of drought for a country such as malawi that is heavily dependant upon the income from its agricultural production ,
said juerg trueb, swiss re' s head of environmental and commodity markets .
insurance does not protect against the reduction of demand resulting from a slightly wetter summer than average, for example, but weather derivatives can do just that. since weather derivatives and insurance cover two different possibilities, a company might have an interest in purchasing both .
weather derivatives typically have a basis to an index which measures a particular aspect of weather. for example, an index might be the total rainfall over a specified period in a specific place. another can be for the number of times the temperature falls below freezing .
f. e. benth and j. saltyte - benth, “stochastic modelling of temperature variations with a view towards weather derivatives, ”
f. e. benth and j. šaltyte - benth, “stochastic modelling of temperature variations with a view towards weather derivatives, ”
a preliminary assessment of the utility of seasonal forecasts for the pricing of u. s. temperature based weather derivatives risk management solutions 2004
asu 2016 - 05, effect of derivative contract novations on existing hedge accounting relationships — a consensus of the fasb emerging issues task force (issued march 2016; effective december 15, 2016, for public entities) .
the value of a cme weather futures contract is determined by multiplying the monthly hdd or cdd value by $ 20. in the example above, the cme november weather contract would settle at $ 4, 160 ($ 20 x 208 = $ 4, 160) .
in the late 1990s, people began to realize if they quantified and indexed weather in terms of monthly or seasonal average temperatures and attached a dollar amount to each index value, they could in a sense
package
and trade weather. in fact, this sort of trading would be comparable to trading the varying values of stock indices, currencies, interest rates and agricultural commodities. the concept of weather as a tradeable commodity, therefore, began to take shape. (for related reading, see: how do you trade the weather? )
until recently, insurance has been the main tool used by companies for protection against unexpected weather conditions. but insurance provides protection only against catastrophic damage. insurance does nothing to protect against the reduced demand businesses experience as a result of weather that is warmer or colder than expected .
a. zapranis and a. alexandridis, “modelling the temperature time - dependent speed of mean reversion in the context of weather derivatives pricing, ”
b. dischel, “black - scholes won' t do. weather risk special report, ” energy and power risk management, october 1998 .
we use the monte carlo method to generate a set of paths and for each of these paths we calculate the payoff. then, the average of the payoffs from all the generated paths will represent the expected price of the derivative .
asc 815 - 15 provides guidance for embedded derivatives that may be included in
[ c ] ontracts that do not in their entirety meet the definition of a derivative instrument, such as bonds, insurance policies, and leases .
to our knowledge, little literature has been developed for the temperature model of henan province, which is the most important state granary in china and is also a major financial market of china. in order to ensure food security, it is necessary to transfer the weather risk of henan province into financial markets through developing weather derivatives. so the main objective of our research is to take the first step to construct weather models for developing weather derivatives in henan province. we construct a temperature model for the first time for zhengzhou (see figure 1), which is the capital of henan province .
brockett et al. [ 8 ] applies the indifference pricing approach in a mean - variance setting to valuate weather derivatives. davis [ 12 ] introduces the marginal utility approach to pricing of weather derivatives, which is based on hedging in correlated assets and modelling of the index as a geometric brownian motion. platen and west [ 13 ] suggest using a world index as a benchmark for weather derivatives pricing. equilibrium theory has also been a popular approach for pricing weather derivatives. cao and wei [ 14 ] apply this to analyse us temperature futures (see also hamisultane [ 15 ] for a more recent study) .
the daily average temperature is calculated by averaging each day’s maximum and minimum temperature from midnight - to - midnight. given a weather station, let us note by
a. zapranis and a. alexandridis, “weather derivatives pricing: modelling the seasonal residuals variance of an ornstein - uhlenbeck temperature process with neural networks, ” in
p. l. brockett, m. wang, c. c. yang, and h. zou, “portfolio effects and valuation of weather derivatives, ”
the risks businesses face due to weather are somewhat unique. weather conditions tend to affect volume and usage more than they directly affect price. an exceptionally warm winter, for example, can leave utility and energy companies with excess supplies of oil or natural gas (because people need less to heat their homes). or an exceptionally cold summer can leave hotel and airline seats empty. although the prices may change somewhat as a consequence of unusually high or low demand, price adjustments don' t necessarily compensate for lost revenues resulting from unseasonable temperatures. (for related reading, see: what impact does weather have on my investment in the weather industry? )
get access to recent and historical weather settlement data for active and recently expired contracts in the u. s. , canada, europe, asia, and austrailia .
it is estimated that nearly 20% of the u. s. economy is directly affected by the weather, and the profitability and revenues of virtually every industry—agriculture, energy, entertainment, construction, travel and others—depend to a great extent on the vagaries of temperature. in a 1998 testimony to congress, former commerce secretary william daley stated ,
weather is not just an environmental issue, it is a major economic factor. at least $ 1 trillion of our economy is weather - sensitive .
here, we should mention that the temperature of the physical formation process is extremely complex, especially for complex regional climates of china; the study on the technical design temperature option is not enough and still worthy of more in - depth theoretical exploration and practices. we should develop more weather models for each geographic region for the weather derivative market in china. in addition, it is also necessary to further develop more precise temperature models for weather derivatives pricing. many other mathematical tools, such as wavelet functions, b - spline functions, and polynomial function, can be used for a more accurate modeling of temperature data. it would be interesting to treat carefully the jumps of temperatures due to extreme phenomena by integrating a term which describes their behavior within the stochastic model. this will make it possible to improve the performance of the daily scale modeling. in the end, we emphasize that it is also important to construct accurate weather models for other weather factors, such as the rain, the snow, or the fog, since the risks implied by these factors also deeply affect economic development of china .
the main users of weather derivatives are energy companies as demand for their products can vary drastically due to extreme weather conditions. the agricultural industry is the second main user of such instruments although other purchasers include firms arranging major sporting (outdoor) events and even tour operators. hedge funds are reputedly also major investors in this alternative asset class .
you can buy weather derivatives as an individual, but you' ll want to consider the trading costs carefully to ensure that your risk of loss is worth the expense .
w. härdle and b. lopez cabrera, “infering the market price of weather risk, ” discussion paper, sfb 649, humboldt - universität zu berlin, 2009 .
for european cities, cme' s weather futures for the hdd months are calculated according to how much the day' s average temperature is lower than 18° celsius. however cme weather futures for the summer months in european cities are based not on the cdd index but on an index of accumulated temperatures, the cumulative average temperature (cat) .
the weather derivatives market trades both over - the - counter (otc), through brokers, and over an exchange, cme group. however, there is a direct interplay between these two marketplaces. weather trades are very often confirmed otc, and then
given up
to the cme for clearing. in this case, counterparties strike a bi - lateral transaction using a broker then process the trade through the cme, using established credit facilities to speed execution. [ 1 ]. the major weather brokers are :
we focus on catastrophe bonds, insurance - linked securities, alternative reinsurance capital, insurance & reinsurance linked investments. we also cover life, weather risk and longevity risk transfer .
the cereal company and the amusement park might buy futures contracts with an underlying weather index based on rainfall. the home heating company might want contracts based on a temperature index .
finally, weather risk is also unique in that it is highly localized, cannot be controlled and, despite great advances in meteorological science, still cannot be predicted precisely and consistently .
the weather market has grown tremendously over the last few years and participants trade over - the - counter and exchange - listed products at cme. the first weather derivative deal was in july 1996 when aquila energy structured a dual - commodity hedge for consolidated edison co (con ed). the transaction involved coned' s purchase of electric power from aquila for the month of august. the price of the power was agreed to, but a weather clause was embedded into the contract. this clause stipulated that aquila would pay coned a rebate if august turned out to be cooler than expected. the measurement of this was referenced to cooling degree days measured at new york city' s central park weather station. if total cdds were from 0 to 10% below the expected 320, the company received no discount to the power price, but if total cdds were 11 to 20% below normal, con ed would receive a $ 16, 000 discount. other discounted levels were worked in for even greater departures from normal [ 2 ] .
explanation: here is an explanation in the case of weather insurance, which basically says that such analysis applies past experience to current positions, as your own text indicates .
burn rate
generally refers to the rate at which something like a contract (or maybe an insurance reserve) for example is consumed. burn analysis burn analysis is the simplest form of weather derivative pricing. it involves taking historical values for the index (which may be based on raw, cleaned, or enhanced data, and which may have been detrended in some way) and applying the financial contract to them. depending on the quality of the data used to calculate the historical indices used, burn analysis may give a useful first indication of the mean and range of possible payouts of a weather derivative contract, and can be done simply in a spreadsheet. the disadvantages of burn analysis are that it may not capture the possible extremes and may be unduly influenced by individual years in the historical record. it can also not be extended easily to analyse a portfolio of contracts. i am also pretty sure no insurance company would ever refer to
burn rate
in reference to fire insurance .
also, since the contract is index - based, buyers of weather derivatives do not need to demonstrate a loss. in order to collect insurance, on the other hand, damage must be shown .
we present our findings as follows. in the next section we review the basics of the cme market for weather derivatives. next, in section 3, our temperature model with seasonal stochastic volatility is defined and analysed. section 4 contains results on the futures price dynamics for some commonly traded products at the cme. some empirical considerations of our model and its applications to weather derivatives are presented in section 5 .
shane joined nobel weather associates in 2010 at its inception under the name snowcast solutions. during that time, he has been focused on developing the analytics, product capabilities, and patent expansion. (continue reading )
this is the first book to cover all the meteorological, statistical, financial, and mathematical issues that rise in pricing and risk management of weather derivatives. abstracts of public administration, development, and the environment
in contrast to the various outlooks provided by government and independent forecasts, weather derivatives trading gave market participants a quantifiable view of those outlooks ,
noted agbeli ameko, managing partner of energy and forecasting firm enercast .
the remainder of the paper is organized as follows. we introduce the basic concepts of weather derivative in section 2. section 3 proposes a seasonal mean and volatility model that describes the daily average temperature behavior using the mean - reverting ornstein - uhlenbeck process. the unknown parameters of the process will be estimated with 62 years of daily average temperature from zhengzhou (57083) meteorological station. then we discuss the pricing model of hdd option based on the temperature forecasting model and price the hdd option with monte carlo simulation in section 4. section 5 explains findings of our research and contains concluding remarks .
the main purpose of this paper is to present a feasible model for the daily average temperature on the area of zhengzhou and apply it to weather derivatives pricing. we start by exploring the background of weather derivatives market and then use the 62 years of daily historical data to apply the mean - reverting ornstein - uhlenbeck process to describe the evolution of the temperature. finally, monte carlo simulations are used to price heating degree day (hdd) call option for this city, and the slow convergence of the price of the hdd call can be found through taking 100, 000 simulations. the methods of the research will provide a frame work for modeling temperature and pricing weather derivatives in other similar places in china .
broadly speaking, cme weather futures and options on futures are exchange - traded derivatives that, by means of specific indexes, reflect monthly and seasonal average temperatures of 15 u. s. and five european cities. these derivatives are legally binding agreements made between two parties and settled in cash. each contract is based on the final monthly or seasonal index value determined by earth satellite (earthsat) corp, an international firm specializing in geographic information technologies. other european weather firms determine values for the european contracts. earthsat works with temperature data provided by the national climate data center (ncdc), and the data it provides is used widely throughout the over - the - counter weather derivatives industry as well as by cme .
asc 815, derivatives and hedging, provides comprehensive guidance on derivative and hedging transactions. it sets forth the definition of a derivative instrument and specifies how to account for such instruments, including derivatives embedded in hybrid instruments. in addition, asc 815 establishes when reporting entities, in certain limited, well - defined circumstances, may apply hedge accounting to a relationship involving a designated hedging instrument and hedged exposure. hedge accounting provides an alternative, special way of accounting for such relationships. asc 815 also provides guidance on how reporting entities determine whether an instrument is (1) indexed to the reporting entity’s own stock and (2) considered to be settled in the reporting entity’s own stock. such a determination will dictate whether an instrument should be accounted for as debt or equity and the appropriate accounting for the instrument. finally, asc 815 addresses the accounting for non - exchange - traded weather derivatives. the codification also provides certain industry - specific derivatives and hedging guidance, but such guidance is included in the industry sections of the codification .
the advantages of these products are becoming increasingly known: the trading volume of cme weather futures in 2003 more than quadrupled from the previous year, totaling roughly $ 1. 6 billion in notional value, and the momentum of this volume continues to increase .
when not managing a weather derivatives exchange, i am a senior business analyst / consultant helping businesses organize and develop digital solutions to reduce operational & regulatory risk. i specialize in specifying requirements for large data integration projects for capital markets, custody and risk management .
mr. noyes founded nobel weather associates under its original name, snowcast solutions, in 2010. this new business leveraged bill’s trading experience and was spawned while running mac’s property maintenance services, a regional snow removal company in the chicago area. (continue reading )
list of figures list of tables acknowledgements 1. weather derivatives and the weather derivatives market 2. data cleaning and trends 3. the valuation of single contracts using burn analysis 4. the valuation of single contracts using index modelling 5. further topics in the valuation of single contracts 6. valuation of single contracts using daily methods 7. modelling portfolios 8. managing portfolios 9. introduction to meteorological forecasts 10. the use of meteorological forecasts in pricing 11. arbitrage pricing models 12. risk management 13. modelling non - temperature data appendices references index .
temperature futures may be used by energy producers to hedge their demand risk (see perez - gonzales and yun [ 7 ] for a study of weather hedging of us energy utilities). other typical users of such futures contracts for hedging purposes are electricity retailers, holiday resorts, producers of soft drinks and beer, or even organisers of outdoor sport events, and fairs. also investors have seen the potential in weather derivatives as a tool for portfolio diversification, since the derivatives are not expected to correlate significantly with the financial markets (see brockett et al. [ 8 ]) .
list of figures; list of tables; acknowledgements; 1. weather derivatives and the weather derivatives market; 2. data cleaning and trends; 3. the valuation of single contracts using burn analysis; 4. the valuation of single contracts using index modelling; 5. further topics in the valuation of single contracts; 6. valuation of single contracts using daily methods; 7. modelling portfolios; 8. managing portfolios; 9. introduction to meteorological forecasts; 10. the use of meteorological forecasts in pricing; 11. arbitrage pricing models; 12. risk management; 13. modelling non - temperature data; appendices; references; index. show more
a classical approach that was used to derive the price of a temperature derivative is the performing of simulations based on historical data, known as hba (history burn analysis). hba is very easy to calculate since there is no need to fit the distribution of the temperature or to solve stochastic differential equations. however, this method can only price the contract roughly since the assumption is not correct usually. it is apparent that the temperature time series is not stationary but contains seasonality, jumps, and trends [ 1 – 4 ], so this method is bound to be biased and inaccurate .
since temperature exhibits strong and clear seasonality, the mean - reverting o - u process is proposed in most weather derivatives literature. dischel [ 15 ] argued that the classical black - scholes - merton pricing approach cannot be directly applied in weather derivatives pricing. he is the first person who proposed a continuous stochastic model in temperature forecasting. dornier and queruel [ 16 ] use a more general arma model than the ar (1) model proposed by [ 17 ], where benth and saltyte - benth fitted norwegian data by modeling the dat variations with a mean - reverting process where the noise process is modeled by a generalized hyperbolic levy process. instead of the fbm used in their previous work, they expanded the work of dornier and queruel. in order to rectify the rejection of the normality hypothesis, zapranis and alexandridis [ 18 ] replaced the simple ar (1) model by more complex ones. their results from the dat in paris indicate that, as the model gets more complex, the noise part draws away from the normal distribution. swishchuk and cui [ 19 ] applied two daily average temperature models to canadian cities data and derived their derivative pricing applications. göncü [ 20 ] proposes a seasonal volatility model that estimates daily average temperatures of beijing, shanghai and shenzhen using the mean - reverting ornstein - uhlenbeck process and then derive analytical approximation formulas for the sensitivities of these contracts. their results verify the convergence of the monte carlo and approximation estimators .
weather contracts on u. s. cities for the winter months are tied to an index of heating degree day (hdd) values. these values represent temperatures for days when energy is used for heating. the contracts for u. s. cities in the summer months are geared to an index of cooling degree day (cdd) values, which represent temperatures for days on which energy is used for air conditioning. both hdd and cdd values are calculated according to how many degrees a day' s average temperature varies from a baseline of 65° fahrenheit (the day' s average temperature is based on the maximum and minimum temperature from midnight to midnight).
weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions . weather derivatives are index-based instruments that usually use observed weather data at a weather station to create an index on which a payout can be based . this index could be total rainfall over a relevant period - which may be of relevance for a hydro-generation business - or the number where the minimum temperature falls below zero which might be relevant for a farmer protecting against frost damage . unlike " indemnity " insurance-based cover , there is no need to demonstrate that a loss has been suffered . settlement is objective , based on the final value of the chosen weather index over the chosen period . if a payout is due , it is usually made in a matter of a few days with the settlement period being defined in the contract : unlike insurance contracts , there is no " loss adjustment " process . see exotic derivatives . 
weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. weather derivatives are index-based instruments that usually use observed weather data at a weather station to create an index on which a payout can be based. this index could be total rainfall over a relevant period - which may be of relevance for a hydro-generation business - or the number where the minimum temperature falls below zero which might be relevant for a farmer protecting against frost damage. unlike " indemnity " insurance-based cover, there is no need to demonstrate that a loss has been suffered. settlement is objective, based on the final value of the chosen weather index over the chosen period. if a payout is due, it is usually made in a matter of a few days with the settlement period being defined in the contract: unlike insurance contracts, there is no " loss adjustment " process. see exotic derivatives.
weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. weather derivatives are index-based instruments that usually use observed weather data at a weather station to create an index on which a payout can be based. this index could be total rainfall over a relevant period - which may be of relevance for a hydro-generation business - or the number where the minimum temperature falls below zero which might be relevant for a farmer protecting against frost damage. unlike " indemnity " insurance-based cover, there is no need to demonstrate that a loss has been suffered. settlement is objective, based on the final value of the chosen weather index over the chosen period. if a payout is due, it is usually made in a matter of a few days with the settlement period being defined in the contract: unlike insurance contracts, there is no " loss adjustment " process. see exotic derivatives.