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Article
Publication date: 20 March 2007

Karyl B. Leggio

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…

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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.

Details

Managerial Finance, vol. 33 no. 4
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 5 January 2010

Alieva Ghiulnara and Cristina Viegas

The purpose of this paper is to present an overview of weather derivatives markets and to highlight the importance of the contributing factors for weather risk management…

993

Abstract

Purpose

The purpose of this paper is to present an overview of weather derivatives markets and to highlight the importance of the contributing factors for weather risk management such as weather sensitivity, weather forecast, and economic growth. In this paper, the prospective of using weather derivatives in Portugal and why Portugal should use such instruments as well as the potential of Portugal's enterprises are presented.

Design/methodology/approach

This paper attempts to distinguish the reasons for the appearance of a weather derivatives market and the growth potential of the European weather market.

Findings

Successful development of a Portuguese weather derivatives market will require three things. For the successful development of weather derivatives market, a legal and economic framework is needed, as well as the development of new weather products, training of qualified specialists for working with these instruments and attracting companies interested in hedging their profits. A combination of these factors will help growth and will accelerate the development of a weather derivatives market in Portugal.

Originality/value

The paper identifies some conditions that could allow the progress of the weather derivatives market in Portugal.

Details

The Journal of Risk Finance, vol. 11 no. 1
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 26 July 2013

Niels Pelka and Oliver Musshoff

The use of weather derivatives is impaired with a basis risk which diminishes the hedging effectiveness and hinders the distribution of these risk management instruments…

Abstract

Purpose

The use of weather derivatives is impaired with a basis risk which diminishes the hedging effectiveness and hinders the distribution of these risk management instruments in the agricultural sector. A frequently suggested approach to reduce the basis risk is the use of mixed indices composed of several weather variables. The purpose of this paper is to compare the hedging effectiveness of a simple temperature‐based and a simple precipitation‐based weather derivative with that of a derivative based on a mixed index of two weather variables.

Design/methodology/approach

The basis of this comparison are empirical yield time series of the winter wheat production of 32 farms located in central Germany, as well as daily temperature and precipitation data collected by selected weather stations over several years. Insurance is structured as an option on an accumulated weather index and priced by index‐value simulation. In addition, the bootstrapping method is used to improve statistical reliability. The hedging effectiveness is measured non‐parametrically regarding the relative reduction of the standard deviation of winter wheat revenues caused by using weather derivatives.

Findings

The results reveal that mixed index‐based weather derivatives have a significantly higher potential to reduce the risk of winter wheat revenues than simple index‐based weather derivatives. However, using mixed index‐based weather derivatives does not lead to a significantly higher hedging effectiveness than the simultaneous use of several simple index‐based weather derivatives. Moreover, simple index‐based weather derivatives may more easily raise the interest of other industries which could serve as potential trading partners for the agricultural sector.

Research limitations/implications

The authors analyzed the hedging effectiveness of weather derivatives based on simple and mixed indices with regard to the production of winter wheat in Central Germany. To confirm that the present results are generalizable, further research is required for other types of production apart from winter wheat cultivation and with respect to other regions besides Germany.

Practical implications

The focus and results of the present study are very relevant for farmers as well as for potential providers of weather derivatives. The results reconfirm that weather derivative providers should better offer different weather derivatives based on a simple index than complex derivatives that are based on a mixed index.

Originality/value

To the best of the authors' knowledge, this paper is the first that provides a comparative impact analysis of simple and mixed index‐based weather derivatives conducted for real individual farms with regard to their hedging effectiveness.

Details

Agricultural Finance Review, vol. 73 no. 2
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 17 August 2010

Mulong Wang, Min‐Ming Wen and Charles C. Yang

The paper aims to examine theoretically valuation of weather derivatives and their hedging roles in corporate risk management.

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Abstract

Purpose

The paper aims to examine theoretically valuation of weather derivatives and their hedging roles in corporate risk management.

Design/methodology/approach

The paper introduces an extended financial market model in which the weather risk is included as an independent random process and examines the effectiveness of weather derivatives and traditional price forwards in a unified theoretical framework. It also provides a no‐arbitrage approach to price weather derivatives, which theoretically combines the actuarial and financial paradigms.

Findings

The results document that corporate leverage level is an essential factor determining the choice between price forwards and weather derivatives. In some cases; weather derivatives outperform price forwards, while in some other cases; a joint use of both instruments is optimal, depending on the firm's risky leverage level. Interestingly, the paper identifies the case when the leverage level is very high, the positive roles of both instruments diminish and the firm is unhedgeable.

Originality/value

The paper provides important insights to investors and hedgers and extends the literature on corporate risk management.

Details

The Journal of Risk Finance, vol. 11 no. 4
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 6 March 2007

Anil K. Sharma and Ashutosh Vashishtha

This article aims to examine the state of risk management in agriculture and power sector of India, evaluate the effectiveness of weather derivatives as alternative risk…

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Abstract

Purpose

This article aims to examine the state of risk management in agriculture and power sector of India, evaluate the effectiveness of weather derivatives as alternative risk management tools and basic framework required to implement them.

Design/methodology/approach

Applications of traditional risk‐hedging tools and techniques in Indian agricultural and power sectors have proved to be costly, inadequate, and more importantly, a drag on the country's fiscal system. Mostly they offer a hedge against only the price risk. The volume related risk, which is rather more serious and highly weather‐dependent, remains practically unhedged. This study has used existing literature and empirical evidences for analyzing the various issues related to risk management in agriculture and power sector. Traditional derivative strategies have been used to construct weather derivatives contracts with different underlying weather indices.

Findings

The article suggests that how an appropriate weather‐based derivative contract system may be a more flexible, economical and sustainable way of managing the volume‐related weather risk in an economy, like India, having predominant agricultural and power sectors.

Originality/value

The article will be of value to all those who have some stakes in agricultural and power sectors of an economy and would like to mange the volume related risk in these sectors.

Details

The Journal of Risk Finance, vol. 8 no. 2
Type: Research Article
ISSN: 1526-5943

Keywords

Article
Publication date: 3 May 2013

Saqib Khan, Morina Rennie and Sylvain Charlebois

The purpose of this research is to study the weather risk management practices of agriculture producers. In particular, the authors look at the extent to which farmers use…

Abstract

Purpose

The purpose of this research is to study the weather risk management practices of agriculture producers. In particular, the authors look at the extent to which farmers use weather derivatives to complement insurance. Unlike insurance, weather derivatives mitigate risk associated with low intensity, high probability events and therefore offer the potential of a more complete hedge than insurance alone.

Design/methodology/approach

The authors conducted a survey of grain farmers in the province of Saskatchewan, Canada, a typical jurisdiction in which farmers tend to face weather events that are high in frequency but low in severity, to study the usage of weather derivatives compared to insurance and identify the hurdles to their usage.

Findings

The authors find that fewer than 10 percent of their respondents use weather derivatives. Consistent with previous literature in other contexts, they identify participation costs, especially lack of awareness, to be the most significant hurdle to their usage.

Research limitations/implications

A limitation of this study is that the data were collected using a survey methodology and are therefore subject to the usual risks of bias associated with that approach. Moreover, because the authors' survey was delivered online, it may have favoured the participation of farmers that were more comfortable with technology and some bias may have also been introduced into the data as a result.

Practical implications

The authors' findings suggest that there is significant potential to improve farmers' ability to hedge weather risk and thereby improve economic outcomes if the major barriers to the usage of weather derivatives can be overcome. The study paves the way for further research to support the development of public policy strategies that could help farmers take advantage of weather derivatives as part of their inventory of risk management tools.

Originality/value

To the authors' knowledge this is the first study that quantifies the usage of weather derivatives by agriculture producers and identifies the hurdles.

Details

Agricultural Finance Review, vol. 73 no. 1
Type: Research Article
ISSN: 0002-1466

Keywords

Article
Publication date: 1 March 2003

CESARE DOSI and MICHELE MORETTO

Weather derivatives have emerged as a generally acknowledged, if not widely utilized, risk management product within the past 5 to 10 years. The authors of this article…

Abstract

Weather derivatives have emerged as a generally acknowledged, if not widely utilized, risk management product within the past 5 to 10 years. The authors of this article compare the costs and benefits of weather derivatives in relation to insurance contracts for hedging weather risk, within the context of long‐term trends in hedging demand due to global warming. The article finds that, as global warming results in increased climactic variation and greater frequency and intensity of climatic anomalies (i.e., higher volatility), derivatives may provide coverage at a lower cost than standard insurance.

Details

The Journal of Risk Finance, vol. 4 no. 4
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 1 February 2000

LIXIN ZENG

This article briefly reviews the background of weather derivatives. The primary goal is to develop a pricing scheme that accommodates and reflects their unique…

Abstract

This article briefly reviews the background of weather derivatives. The primary goal is to develop a pricing scheme that accommodates and reflects their unique characteristics. Because the underlying indexes of weather derivatives are not traded, a no‐arbitrage model cannot be directly applied for the purpose of pricing. The actuarial technique is a feasible choice but cannot be applied in the traditional fashion, because the historical data are characterized by long‐term variability and trends that are difficult to define and correct based purely on the data. The pricing scheme developed in this article attempts to address these concerns by combining information from both empirical analysis of historical data and numerical simulations.

Details

The Journal of Risk Finance, vol. 1 no. 3
Type: Research Article
ISSN: 1526-5943

Article
Publication date: 1 June 2005

Hélyette Geman and Marie‐Pascale Leonardi

The goal of the paper is to analyse the various issues attached to the valuation of weather derivatives. We focus our study on temperature‐related contracts since they are…

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Abstract

The goal of the paper is to analyse the various issues attached to the valuation of weather derivatives. We focus our study on temperature‐related contracts since they are the most widely traded at this point and try to address the following questions: (i) should the quantity underlying the swaps or options contracts be defined as the temperature, degree‐days or cumulative degree‐days? This discussion is conducted both in terms of the robustness of the statistical modelling of the state variable and the mathematical valuation of the option (European versus Asian). (ii) What pricing approaches can tackle the market incompleteness generated by a non‐tradable underlying when furthermore the market price of risk is hard to identify in other traded instruments and unlikely to be zero? We illustrate our study on a database of temperatures registered at Paris Le Bourget and compare the calls and puts prices obtained using the different methods most widely used in weather markets.

Details

Managerial Finance, vol. 31 no. 6
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 1 January 2000

Don Ellithorpe and Scott Putnam

Major segments of the U.S. economy are affected by weather. With the emergence of weather derivatives, exposure to weather‐related risk has evolved from being merely…

Abstract

Major segments of the U.S. economy are affected by weather. With the emergence of weather derivatives, exposure to weather‐related risk has evolved from being merely accepted. As a result, weather risk management strategies are increasingly being adopted in strategic decision‐making by senior management. Weather derivatives enable managers to focus on core operating risks by trading away those business exposures related to temperature, precipitation, snow level, etc. These contracts offer a unique opportunity to discretely trade a new category of risk, which was previously considered to be an inevitable cost of doing business. This article describes the weather derivatives market and its contracts and outlines the principles of pricing and risk analysis in weather markets. In closing, the article discusses the application of these products for portfolio and business risk management using illustrative examples from the energy markets.

Details

The Journal of Risk Finance, vol. 1 no. 2
Type: Research Article
ISSN: 1526-5943

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