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Abstract: 

The use of weather derivatives to hedge against weather-related risks is a recent phenomenon, beginning in 1996 with firms in the energy industry. Although standardized weather contracts began trading on the Chicago Mercantile Exchange in 1999, they are of little value for many specialized applications in government and the private sector. The recent increase in the availability of weather contracts in the over-the-counter market, however, provides a wide range of tools for managing weather-related risks. Using snowfall data for a typical Canadian city, we show that weather derivatives can be effectively used to hedge the financial risks in snowfall removal expenditures. The debate regarding an accepted approach to pricing such contracts, however, remains a critical issue.

Keywords: Option prices; burn rate analysis; monte carlo simulation

Affiliations:  1: Brock University; 2: Brock University; 3: Brock University; 4: Brock University.