Inc. All rights reserved. A weather derivative is a financial contract whose value is based on climatic data such as temperature, precipitation, windspeed, etc.
Many companies have uncertainty in their revenues or expenses caused by weather volatility.
By transacting weather derivatives, these companies can hedge themselves against the volatility, and eliminate or reduce the uncertainty in cash flows. The major users of weather hedges are energy producers and distributors, whose incomes are closely tied to temperature's impact on heating and cooling demand from consumers. Agricultural businesses that produce, transport or store crops have financial exposure to the both temperature and precipitation. The travel industry experiences shifting revenues when weather conditions vary from expectations. Many industries in the consumer products arena have exposure to the purchasing behavior of the public.