Using weather derivatives to hedge precipitation exposure

Abstract

Purpose

The purpose of this study is to demonstrate the use of weather derivatives to hedge firm exposure to previously unmanageable risk events caused by natural phenomenon such as excessive rainfall.Design/methodology/approach – The paper adopts a case study approach to meet the objectives above, focusing on golf courses in the Midwest USA, which provide perfect examples of businesses with seasonal cash flows.Findings – It is shown that a firm can reduce its revenue volatility by up to 80 per cent. Weather derivatives are important additions to firm portfolios of risk management tools. Purchasing weather derivatives will improve the owner's ability to forecast revenues and assure expenditure coverage, both important goals for a small business owner.Practical implications – Many firms find the uneven revenue streams associated with their industry to be difficult to manage. One of the primary risks faced by firms is exposure to weather phenomena. With the introduction of weather derivatives, firms can now hedge their exposure to climatologic events. The application for weather derivatives is quite limitless. Weather derivatives are a relatively new product, and most firms are either unaware of their existence or believe them to be complicated. It is an industry that may experience explosive growth in the coming years.Originality/value – This paper demonstrates the use of derivatives to hedge exposure to climatic events.

Citation

Leggio, K.B. (2007), "Using weather derivatives to hedge precipitation exposure", Managerial Finance, Vol. 33 No. 4, pp. 246-252. https://doi.org/10.1108/03074350710721497