Applications of weather derivatives in the energy market

Abstract

Abstract: This paper analyzes various types of weather related risks in di erent industries. Sincethe existence and popularity of the established weather insurance market, we also discuss the di er-ences between weather derivatives and insurances and the advantages of using weather derivativesinstead of insurances in weather risk management. For the applications of the temperature futures, rstly, we gave out a static, simple strategy example to hedge the volume risks in practical. Then,by building up a system of models for energy and temperature, we proposed a dynamic hedgingstrategy for the hedge of the energy futures using temperature futures.Keywords: Weather derivatives; Mean-reverting process; Energy market; Dynamic hedging 1 Introduction Weather, especially temperature, risks have signi cant impacts on the operational and nancialdecisions and revenues of various industries, such as energy producers, distributors and retailers.According to the present situation of the notably increasing occurrence of extreme weather andextreme temperature volatility at high latitudes, weather is a ecting the supply and demand inbusiness more gravely. Under this circumstance, hedging strategies and weather derivatives thatcan be deployed to transfer these risk exposures to willing counter parties become increasinglyvaluable and useful. As an application of weather derivative to other commodities markets, theprimary objective of this paper is to consider the cross hedging strategy with other commoditiesusing weather future contracts.