Hedge Demand and Performance of Weather Derivative Product : Focusing on Natural Gas Industry in Korea
Authors:   Asia-Europe Perspective Association, Moon Seongju , Sohn Pando 
Published: June 2018

This paper develops and evaluate how weather derivative product is applied to natural gas industry. If developed weather derivative product is used as hedge tool, what is hedge performance from natural gas industry in Korea. Recently weather derivative product is developed as hedge tool because the loss from natural catastrophe in past time was small amount and also this loss is hedge easily. However, today, huge loss from natural hazard is not covered by only insurance coverage. Instead of insurance tool, many papers suggest the weather derivative product which is good tool to cover huge loss from natural catastrophe. A financial weather contract can be defined as a weather contingent contract whose payoff will be in an amount of cash determined by future weather events. The settlement as values of a weather variable measured at a stated location. A financial weather contract can take the form of a weather derivative or of a weather insurance contract. While the differences between the two types of contracts might be important from regulatory and legal viewpoints, from an economic perspective both instruments share the common feature of being triggered by an underlying weather index. In discussing agricultural policy and risk management tools, this is probably the most relevant aspect. Weather derivative financial product contract can be used to hedge businesses exposition to weather variables. If the activity of a firm is influenced by temperature, snowfall or shushine, a derivative on the appropriate weather variable could be used to reduce revenue fluctuation. Weather has always been a source of risk for many economic activities, but it was not until the late 1990's that firms explored the possibility of hedging against weather-related variability through weather derivatives. The impetus for developing weather markets was given by the deregulation of the US energy sector, when local monopolies had to start competing on broader markets and find measures to stabilize fluctuating revenues. Ordinary insurance and reinsurance tools were traditionally designed to target cata-strophic events, and were probably too expensive and not sufficiently flexible for ordinary risk management practices that focus on fluctuations closer to the mean of the distribution. Faced with these challenges, energy traders started thinking of financial solutions for trading their exposure to weather risks within their own industry. In this paper, we focuses on the natural gas industry and investigates the hedge demand and performance using daily weather data. The natural gas industry is one of most important energy industry and thus analyzing this natural gas industry is contrubution to development of weather derivative product and hedge of huge natural catastrophe risk. From this paper, we develop the weather derivative product appropriated to Korean natural gas industry and also evaluate the hedge demand and performance. The empirical results are as follow: we find that big hedge demand in Korean natural gas industry exists from hedge performance and demand. Also we show that if it is hedge based on HDD futures and options, cost in hedge case is less than cost in no hedge case and also we find that there is no excess than allowed risk level. We think that this paper give us new prospective view in terms of financial innovation and financial engineering as well as financial industry.