Weather rebate contracts for different risk attitudes of supply chain members

Abstract

Firms that deal with weather-sensitive products are often exposed to weather risk. How a weather rebate contract can be implemented to improve the performance of a supplier-retailer supply chain is investigated. The supplier offers a weather rebate to the retailer to compensate for the loss of sales due to weather risk. Depending on certain weather conditions, the retailer receives the rebate if it orders beyond a predefined ordering quantity. Depending on its risk attitude, the supplier uses weather derivatives to minimize the downside risk. The performance of weather rebate contracts is analyzed for three cases: risk-neutral supplier and risk-averse retailer, risk-averse supplier and risk-neutral retailer, and risk-averse supplier and risk-averse retailer. Conditional Value at Risk (CVaR) is used as the risk measure. The supply chain coordination under weather risk is investigated, and the specific conditions of a weather rebate contract leading to a Pareto-improving solution for both parties are obtained. To the best of the authors’ knowledge, this is the first study that investigates the weather rebate contract incorporating the risk attitude of the firms using a cooling degree days (CDD)/heating degree days (HDD)-based rebate structure. A comparative analysis between the weather rebate and wholesale price contracts is carried out based on the actual temperature and demand data. The results show that the weather rebate contract outperforms the regular wholesale price contract in all three cases. The study also demonstrates how to use weather derivatives to improve the performance of a supply chain dealing with weather-sensitive products.