Weather derivatives are financial instruments that are bought/sold on agreed terms whereby involved parties will receive compensation if the average temperature or precipitation reaches certain levels. Weather derivatives are used to hedge the risks of businesses such as tourism firms, restaurant operators and food manufactures that are vulnerable to unseasonable weather, especially in the summer and winter. Trading in such instruments began in the U.S. in the second half of the 1990s and nonlife insurance companies began selling them to corporate customers in 1999 in Japan. Recently introduced derivatives are based on the strengths of winds or waves in the sea. The global market for weather derivatives is estimated to be worth 500 billion yen, of which the Japanese market accounts for 10%.
Derivative products whose values depend on risky weather variables, such as temperature, precipitation, or dollar damage from extreme weather. E.g., options on heating or cooling degree days, hurricane-based catastrophe bonds.
forward instruments used to hedge against or speculate on weather. Virtually all the instruments are based on degree-days, although precipitation swaps and sunshine options are among other possible instruments. see also sunshine option
Business contracts, established betwen two firms to provide financial coverage for specific weather risks, that serve as a form of hedging against potential losses. The weather risk is the uncertainity in cash flow and earnings due to weather variability. Risks typically covered for a firm in the energy industry are the number of heating or cooling degree- days, and for agribusinesses, the amount of growing season rainfall or the number of July days with temperatures above 32°C (90°F).
Weather derivatives are financial instruments that can be used by organisations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. The difference from other derivatives is that the underlying asset (rain/temperature/snow) has no direct value to price the weather derivative. 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.