When one designates weather derivative thereby derivative a financial instrument with which meteorological data are e.g. used like the temperature or amounts of precipitation as base value. Weather derivatives are usually locked between a bank and an enterprise, whereby the enterprise transfers its weather risk on the bank. Since according to estimations by economists world-wide for instance four-fifths of all economic activities are directly or indirectly affected by weather, weather derivatives can an instrument risk management of the enterprise represent. Only toward end of the 1990er years developed weather derivatives are however still another relatively recent instrument at the financing market, which are little standardized differently than safeguard instruments for change of interest or rate of exchange risks. Weather Future as standardized product are acted so far to only very small extent to Chicago Mercantile Exchange and the LIFFE in London.

Example of a risk transfer by a weather derivative

With the following - designed - example the function mode and application type can be simply described by weather derivatives:

A farmer, who cultivates peaches in Central Europe, is dependent on the fact that during the bloom time of the frost-sensitive trees the temperature never falls under a certain temperature. The longer the temperature below five degrees Celsius lies, the smaller is its harvest quantity. Its economical risk can transfer this farmer to a bank, by locking an appropriate weather derivative with its house bank. Contract could so out-arranged to be that the farmer for each day of the months April and May - thus the months, in which the frost-sensitive flower -, on which the temperature under 5"°, measured by the nearest Wetterstation, Celsius sinks, a balancing amount from 1.000 euro receives. Whether it pays an option premium for the present Treaty, or whether it has a payment obligation opposite the bank, if the temperature lies over five degrees Celsius, depends on which specific safeguard instrument is selected.

The security instruments

The characteristic of weather derivatives compared with other derivatives financial products

The instruments, which are used with weather derivatives, essentially correspond to the usual derivatives safeguard business, which is used in the finance management in their construction. Weather derivatives exhibit however a characteristic: The objects, on refer - called in the technical language base values -, i.e. daytime temperatures, snow height, amounts of precipitation or the like, are not not tradable. That has some consequences in enterprise practice and in financialmathematical handling this instrument. The of the weather derivatives is derived alone from the historical meteorological data. There are no in the classical sense, how it is approximately for security instruments for shares or currencies the case. Differently than with shares or with raw goods as for instance silver is also not influenceable by individual market participants the base value, in whom for example at certain times large quantities of these are sold or market participants on price rises to speculate. The base value of weather derivatives can be regarded as free of market manipulations.

Differently than with other derivatives safeguard instruments a physical supply is impossible with maturity with the weather derivative. Became if the farmer, who cultivates peaches, its prospective herbstliche harvest quantity in the spring on date to already sell, it could actually also supply the agreed upon quantity of the day of maturity its fixed price business to its contractor with. Such option dealings - at goods futures exchanges like in Chicago being actually locked - usually however by compensations are expenditure-resembled. With weather derivatives this so-called bar reconciliation is however the only possibility of terminating the business.

As still problematic the selling price calculation is considered with the weather derivatives. The Black Scholes model, which is used otherwise according to standard for selling price calculation, does not fit for this instrument. A Monte Carlo simulation, which can be alternatively used, is very complex in its application. While banks can usually still illustrate this due to their software equipment, this represents a problem in particular for enterprises, which must be due to enterprise-internal regulations able to be able to evaluate final financial derivatives independently. Conclusions in weather derivatives would accompany with these enterprises with a complex armament of their Treasurysysteme.

The base values of weather derivatives

Weather derivatives can referenzieren on a very large of different base values, since there is a multiplicity of possibilities to quantify weather. For the security of business risks the appropriate weather derivative must refer however to the correct base value, in order to represent a meaningful security. In the example peaches of the cultivating farmer stated above the average daytime temperature in Germany or Austria is irrelevant. For it plays a role, which temperature close of its peach plan days is measured. A municipality, which would like itself against to high costs of evacuation of snow to secure, is crucial not the snow on the course point, but the locally measured.

Temperature is furthest common as weather measure. After an investigation of the Weather Risk management Association 2002 95% of the final weather derivatives of temperature levels had as base value. Other base values are the wind velocity, snow and rain, water level, cloud coverage, duration of sunshine or the relative air humidity. For snow and rain once per day in the last 24 hours the measured amounts of precipitation in millimeters are measured.

The exemplary farmer, who would like to secure the temperature dependence of its peach harvest, will fall with difficulty it to find a Wetterstation which lies in so large proximity to its Plantage that it correctly shows the temperature substantial for him. For it however the possibility exists of combining the values in such a way several Wetterstationen that the probability rises that thereby the temperature relevant for it is indicated. Other enterprises with another risk structure than exemplary farmers lock more long-term contracts, since with the fact it is rather ensured that they receive a disbursement from the final weather derivative, which corresponds to its business risk.

The security instruments

In the terminology, structure and completion practice weather derivatives correspond to the usual financial derivatives. Options and option dealings are the usual transaction forms, which are used here. Particularly options are thereby typical instruments, which constitute about 70 to 80% of the conclusions according to estimations of market participants. As is the case for the security of rate of exchange and risks of change of interest are conceivable thereby a set of option structures, which can be out-arranged very differentiated according to the risk profile.

Option dealing

An option dealing - called in this connection in the technical language frequently Swap - is the most simply comprehensible instrument in the context of the weather derivatives. A premium payment is void here, instead exchanges bank and enterprise weather risks. For peach-cultivating farmer will this agreement with its bank to mean, with which it receives a disbursement amount for each day, on which the temperature in the period sinks April and May under five degrees Celsius, from 1.000 euro. Turned around the farmer must for each day, because of which the temperature is over five degrees Celsius, 1,000 Eur to the bank pays with this type of transaction. The maximum disbursement amount for both contractors would be with the present contract Treaty with 61.000 Eur. Before the signature under the present Treaty the farmer must decide however whether this construction corresponds at all to its risk profile. To this analysis among other things an occupation with the question belongs whether it loses really only 1,000 euro at harvest, if the temperature in this period falls on for example -5 degrees Celsius and the entire bloom of the trees is destroyed thereby. Turned around must it itself to ask, whether with each day, because of which the temperature is over five degrees Celsius it will really have an auxiliary quantity of harvest, which corresponds to the 1,000 euro in the autumn, which it has to then pay to the bank.

The example of a producer of ice cream shows however that an option dealing can be designed in such a way that it corresponds to a determined risk structure. Due to preceding analyses white this producer that with each additional degrees Celsius, which the average temperature is appropriate in the months June, July and August below 20 degrees it loses it a million Eur conversion and thus 100,000 EUR profit. With each additional degrees Celsius it converts, with which the average temperature lies over 25 degrees Celsius, against it for a million Eur more ice. It wants to compensate these fluctuations in the sales volume by the conclusion of an appropriate option dealing. It locks accordingly to an option dealing with its bank, which the accompanying the profit break-down, which it compensates suffers in an unusually cold summer, with the turnover break-down. The profit, which he would have in an unusually hot summer, it is ready for it to give up.

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