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At the time of writing this review, a sampling of recent financial risk management news includes the following items: Japan's first weather derivative involving high wave levels recently went on sale; a development bank is readying what would be only the second weather-related bond offering for placement in the capital markets; and there are new efforts in the areas of providing real-time weather information and of weather derivative portfolio management software.
Weather derivative contracts may be written and based on the temperature at a station with 25 years of historical data.
Lynda Clemmons, the chief operating officer of Element Re Capital Products in Stamford, Connecticut, says that one client, a regulated utility, had invested in a single-year weather derivative and wanted to purchase a multiyear derivative.
This text points out that a disadvantage of weather insurance is that one has to show an insurable interest while, "An entity executing a weather derivative does not need to show an insurable interest in property, it just needs to be adversely impacted by fluctuations in weather." The text reports that in the year 2000, the General Counsel for the New York Insurance Department indicated that weather derivatives were not insurance.
Businesses, such as those in energy, agriculture and construction, can purchase a weather derivative. This is an instrument whose value depends on the quality of some underlying variable, in this ease, a weather index such as heating degree days, cooling degree days, average temperature or inches of precipitation.
The basic structure of a weather derivative is fairly simple.
The audience heard of the market failure that exists in the crop insurance and weather derivative market, that there is a need to continually improve Farm Management Deposits to ensure greater uptake and utilisation, and that there is a requirement to ensure that government risk management programs focus on preparation rather than reaction.
Brix, Weather Derivative Valuation: The Meteorological, Statistical, Financial and Mathematical Foundations, Cambridge University Press, Cambridge, UK, 2005.
As an institutional response to weather changes, the Chicago Mercantile Exchange (CME) introduced the weather derivative (WD).
Liu, "Modeling and forecasting average temperature for weather derivative pricing," Advances in Meteorology, vol.
In the United States, these risks are now primarily managed using weather derivative products since they became available on the CME in 1997.