Metro
Hedging Corporate Revenues with Weather Derivatives: A Case Study
Master of Science in Banking and Finance - MBF Master’s Thesis
Antoni Ferrer Garcia Franz Sturzenegger
Universit´ de Lausanne e Ecole des Hautes Etudes Commerciales HEC - 2001
Abstract This paper searches for the implications in the use of a new generation of financial derivatives known as Weather Derivatives as a form of hedging future corporate revenues. According to the US Department of Commerce about 22 per cent of the US$ 9 trillion GDP in the United States is sensitive to weather. This figure supports the growth in the market that started at the beginning of the 1997s. Likewise, it is estimated that already some 1,800 deals worth roughly US$ 3.5 billion have been transacted in the U.S. An estimated 70 per cent of all businesses face weather risk which extends across geographic and market borders. The current weather derivatives market is still illiquid and several pricing models are being used by financial institutions. On this paper we show the characteristics, pricing models and hedge strategies about such new contracts. Our case study has been done within a multinational corporation that we will be here called XYZ to preserve its confidentiality.
Acknowledgments
Before starting, we would like to thank all the people that with their support and understanding have contributed to make this master’s thesis somehow better: Mrs. F. Kafader of Kundendienst-Account, Swiss M´ t´ o, Prof. Dusan Isakov ee (HEC - Gen` ve), Mr. J¨ rg Tr¨ b (Swiss Re-insurance), Robert Dischel, Melanie e u u Cao and Jason Wei. Several institutions that have supported us with data, advice or knowledge about the weather derivatives markets: Enron, Aquila Energy, AC Nielsen, Migros, and Koch Energy Trading. Special thanks to company XYZ since it was their idea to write about this topic. It is also theirs most of the data contained on this thesis. With their help and that of Mr. Lagger and Mr. Silen, we started
Master of Science in Banking and Finance - MBF Master’s Thesis
Antoni Ferrer Garcia Franz Sturzenegger
Universit´ de Lausanne e Ecole des Hautes Etudes Commerciales HEC - 2001
Abstract This paper searches for the implications in the use of a new generation of financial derivatives known as Weather Derivatives as a form of hedging future corporate revenues. According to the US Department of Commerce about 22 per cent of the US$ 9 trillion GDP in the United States is sensitive to weather. This figure supports the growth in the market that started at the beginning of the 1997s. Likewise, it is estimated that already some 1,800 deals worth roughly US$ 3.5 billion have been transacted in the U.S. An estimated 70 per cent of all businesses face weather risk which extends across geographic and market borders. The current weather derivatives market is still illiquid and several pricing models are being used by financial institutions. On this paper we show the characteristics, pricing models and hedge strategies about such new contracts. Our case study has been done within a multinational corporation that we will be here called XYZ to preserve its confidentiality.
Acknowledgments
Before starting, we would like to thank all the people that with their support and understanding have contributed to make this master’s thesis somehow better: Mrs. F. Kafader of Kundendienst-Account, Swiss M´ t´ o, Prof. Dusan Isakov ee (HEC - Gen` ve), Mr. J¨ rg Tr¨ b (Swiss Re-insurance), Robert Dischel, Melanie e u u Cao and Jason Wei. Several institutions that have supported us with data, advice or knowledge about the weather derivatives markets: Enron, Aquila Energy, AC Nielsen, Migros, and Koch Energy Trading. Special thanks to company XYZ since it was their idea to write about this topic. It is also theirs most of the data contained on this thesis. With their help and that of Mr. Lagger and Mr. Silen, we started
References: See, for example,recent surveys by Wharton School and Chase Manhattan Bank (1995) and by Ernst and Young (1995) 2 Risk Magazine, March 2000 1 3 The insurance industry defines a catastrophe as “an event which causes in excess of $5 million in insured property damage and effects a significant number of insurers and insurers”. See Louberg´ and Schlesinger (1999) e 12