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Weather Derivative

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Weather Derivative
An instrument used by companies to Hedge against the Risk of weather-related losses.
    
The investor who sells a Weather derivative accepts the Risk by charging the buyer a Premium. If nothing happens, then the investor makes a profit. However, if the weather turns bad, then the company claims the amount. 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.
    
Farmers can use weather derivatives to Hedge against poor harvests caused by drought or frost; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (HDD) or cooling degree days (CDD) contracts to smooth Earnings.
Posted by  Institute for International Research
 
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