Motives MOTIVES AND INSTRUMENTs FOR HEDGING wEATHER RISK.
Firms might seek to manage their exposure to weather risk for a variety of reasons.
Smooth revenues or compensate for the loss of demand. An ice cream manufacturer might seek insurance against an unseasonably cool summer.
Cover excess costs. An unexpected frost could destroy crops and raise the costs to a consumer foods manufacturer. Industrial consumers of energy might seek to hedge against spikes in the cost of purchased electricity associated with peak load demand in the summer Reimburse lost opportunity costs. Ideally, manufacturers would produce, and retailers would stock, the exact quantity of product that customers would buy. Weather introduced uncertainty into estimates of customer demand. In the event of stock-outs, businesses lost the opportunity to sell their products. Firms might seek to hedge this risk, e.g., the ice cream manufacturer might seek weather insurance against stock-outs in an unseasonably hot summer.
Stimulate sales. Customers may delay their purchase decision until a seasonal trend in weather becomes apparent. Cruise lines, resorts, and ski lift operators witness this behavior annually. Firms might use weather derivatives to back up their "money back guar antee" of consumer satisfaction
Diversify investment portfolios. Financial investors might seek to exploit the low cor relation between returns associated with weather and returns from other financial instruments. Weather derivatives could potentially reduce risk and/or increase returns in a portfolio .