First, they carry over the revenue curve from figure 4 as the upper curve in figure 6. The result is the second curve from the top in figure 6, the hedged revenue. Then they multiply each of these curves by the modeled probabilities resulting in the two lower curves in figure 6, the probable unhedged revenue and the probable hedged revenue. They note that the wings on both the unhedged revenue curve and the probable hedged revenue curve, where revenue would be less than USD 3 million are almost completely missing on the two hedged revenue curves. They calculate that the probability of the company receiving revenue less than USD 3 million this coming winter is too small to hedge any further, and there will probably not be a market in the small expected value of these shortfalls.
Negative revenue is possible only at the far extremes of winter at almost zero-probabilities.
They have removed probable negative revenues and have raised the wings of the revenue curve by lowering its crown. The company will survive this winter - whatever the weather. Bob Dischel, now a consultant to the weather market, led quantitative activities at two of the US' largest insurers. Bob was a University Professor and is certified by the American Meteorological Society as a Consulting Meteorologist. This article is Copyright 1999, All Rights Reserved, Robert S. Dischel.