Risk Management
Warren Buffett,
Australian Financial Review,11 March 2002.
AGENDA
Introduction
When to use it ?
Pricing Models
Indian Side
Introduction and
Importance
In 1997 the first over-the-counter (OTC) weather
derivative trade took place, and the field of weather risk
management was born.
The world's first exchange traded weather derivative
began trading on September 22, 1999 at the CME
20% of the U.S. economy is directly affected by the
weather
Weather risk is one of the biggest uncertainties facing
any business
A mild winter ruins a ski season, dry weather reduces
crop yields, & rain shuts-down entertainment &
construction
Till now Energy Companies are major player
Importance
Companies whose earnings fluctuate wildly receive
unsympathetic hearings from banks and potential investors.
Inches of Snow
Solution: A Snowfall call option which pays $250,000 per 1/2 inch
of snowfall above a strike of 12 inches to a maximum of 20 inches
Existing Pricing Models
Arbitrage – Free Pricing
Station Changes
Instrumentation
Location
Trends
Global Climate Cycles
Urban Heat Island Effect
ENSO Cycles
Forecasting
Phoenix CDD Data -
Adjusted
Phoenix CDD Data Adjusted for Trend
3800
3600
3400
3200
3000
2800
2600
2400
2200
Original Adjusted
Phoenix CDD Call Graph
3600
3400
3200
3000
2800
2600
2400
2200
49
54
59
64
69
74
79
84
89
94
99
19
19
19
19
19
19
19
19
19
19
19
Phoenix CDD Call - Impact
of Data Adjustments
CDD Call Structure All Year Expected
Loss
Period = Jun-Sept
Strike = 3,200 Based on
Tick = $10,000 Unadjusted Data:
Limit = $2 mil $826,000
Based on Adjusted
Data:
Calculating the Payoff
Fit a Probability Distribution to
Adjusted Data after simulation
Apply the formula