Hedging Weather Risk: Weather Derivatives

7 INTRODUCTION Everybody talks about weather but nobody does anything about it 1 . This quote, normally and erroneously attributed to Mark Twain instead of its collaborator C. Dudley Warner, encloses the starting point this dissertation strives to discuss more extensively. Despite all the honours may be conceded to Twain and Warner’s literary contributions, it is widely known that people do everything they can to contrast weather implications. From earlier moments of human life, mankind is persevering in fighting adverse weather conditions. Clothes can be considered one of the first attempts in this direction. With the progress of our society, weather events have not only acquired a clear and scientific explanation, but they have been greatly contrasted with newer technologies. Hence, it may be stated that everybody talks about weather (especially when discussions’ topics are exhausted) and everyone constantly tries to do something about it. Thus, it may be argued that people are aware of the uncertainty weather implies in their daily activities. Specifically, it is not hard to find corporate annual financial reports indicating weather as the main cause of the drop in sales or the hike in costs. One of the last technology firms are using to hedge the risk that weather anomalies have on their activities, is the weather derivative. A weather derivative is usually defined as a financial derivative whose underlying is a weather index. Although financial derivatives have often been accused to have played a crucial role in the recent financial crisis, their non- speculative aspect may be extremely useful to support those business activities that are consistently affected by unfavourable climate conditions. The purpose of this paper is to introduce the weather derivatives market and to explain how weather risk management products may be used to contrast adverse atmospheric phenomena. In particular, Chapter 1 is devoted to the analysis of weather implications on economic activities. Specifically, on the one hand relevant academic findings are mentioned to introduce the subject, on the other hand the main effects that weather instability has on companies are discussed. This part ends with the explanation of the distinctive features of catastrophic and non-catastrophic weather risk. Chapter 2 comments the current status of the weather risk management industry. It describes which are the main providers and end-users by discussing the reasons why they are participating to the market. Industry structure and growth are examined by focussing on product and geographic expansion. Moreover, this section highlights main disparities 1 C. Dudley Warner (in collaboration with Mark Twain), “The Gilded Age”, 1837.