What is the weather derivative?

Weather derivative is an example of an investment strategy that includes the consideration of elements such as wind speed, humidity, temperature and other weather conditions that could expose the investment a high risk. Like all forms of derivative investment, weather derivative may include bonds, stocks and other types of commodities. A slightly different is that the seller charges the buyer of the weather and premium derivative, which serves as a protection against losses.

Many tend to consider the weather derivative associated only with high -risk investments that are in some way associated with serious weather conditions. Although it is true that weather derivative performance can be influenced by unexpected weather, such as floods or hurricanes, more common applications are related to temperature fluctuations. Basically, many weather derivative investments are carried out on the basis of temperature projections for a given range of a given range high or low.

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weather derivative acts as a financial tool that helps reduce the amount of risk that can lead to bad weather. With this type of investment, the seller continues to take over the risk of investment. In order to cover this continued responsibility, the seller usually charges the premium for the weather derivative. If there are no unexpected weather conditions, the seller will realize the profit. However, if bad weather occurs and negatively affects the derivative, the buyer benefits from the investment.

The weather derivative differs very much from insurance. The basic difference is that insurance is usually used to cover circumstances that are possible, but are unlikely to occur frequently or for a long time. As a result, insurance is in most cases a somewhat low risk. On the contrary, the weather is involved in precisely predicting circumstances with a high probability of time in a given period.