Weather Future

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Weather Future

A weather derivative in which the buyer is required to pay the seller $20 for each day in a given month that the daily temperature is below 65 degrees (a heating degree day) or above 65 degrees (a cooling degree day), depending on the nature of the contract. A weather future allows a business to hedge against potential losses resulting from an unexpected change in weather. Energy companies are the most common sellers of weather futures; they have become relatively popular investments.
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References in periodicals archive ?
The market allowed the utilities to sell weather futures to investors.
But back in the late '90s, before Enron imploded, it created a huge new market of selling "weather futures" to electric utilities--hedges that would pay out if, say, a mild summer hurt their sales (because people would use less air conditioning).
It then uses that guess to instantly price a weather future or insurance contract.
"Weather futures markets suggest US distillate demand will climb to 4 million bpd (mbpd) in January and February," Goldman Sachs analyst David Greely said in a report, up about 8 per cent from current levels of 3.7 mbpd.
Then in 1999, the Chicago Mercantile Exchange (CME) started to trade weather futures contracts, spurring the expansion of this nascent sector.
while the hedger using linear basis hedging (hedging using the combination of exchange traded weather futures and OTC basis weather forwards) has a final wealth given by
We denote by [h.sub.l-ll], [h.sub.e-lb], [h.sub.d-lb] the hedge ratios of OTC local weather forwards, exchange-quoted weather futures, and OTC basis weather forwards, respectively, [h.sub.l-ll], [h.sub.e-lb], [h.sub.d-lb] are positive when the hedger has short positions in these forwards and futures.
Since the OTC basis forward is intended to be used in conjunction with the exchange traded weather future contract, it is of interest to know when these two contracts yield the same hedge ratio.
For linear basis hedging with both exchange traded futures and OTC basis forwards, the simulation results indicate that the hedge ratio [h.sub.e-lb] (lb denotes "linear basis hedging") on the weather future contract decreases in credit risk.
The OTC basis forward is intended to be used to complement the weather future contract.
From the same people who run weather futures trading, the hurricane futures market could prove to be a viable tool for reinsurers.
Later in the same year, the London International Financial Futures Exchange introduced weather futures that now allow Europeans to hedge against their respective weather conditions.