Weather Derivative

Weather Derivative

An instrument used by companies to hedge against the risk of weather-related losses. The investor who sells a weather derivative agrees to bear this risk for a premium. If nothing happens, the investor makes a profit. However, if the weather turns bad, then the company who buys the derivative claims the agreed amount.

Notes:

This is not the same as insurance, which is for low-probability events like hurricanes and tornados. In contrast, derivatives cover high-probability events like a dryer-than-expected summer.

See also: Commodity, Derivative, Futures, Hedge, Insurance, Risk