Hedging revenues with weather derivatives : a literature review of weather derivatives & a case study of Ringnes AS

Abstract

The corporate world has hedged their revenues for decades. By use of futures, forwards, options and swaps companies have hedged risks related to stock investments, commodities, interest rates, currency and relevant indexes. A common feature for those types of risk is that the risks are mainly related to price. Volumetric risk on the other hand, has largely been left unhedged. A common and important factor to volumetric risk is the weather. Previously adverse weather has often been used as an excuse for poor financial performance, and such excuses have to a large extent been accepted by the market. In the late 90’s a new financial market was developed. A market for weather derivatives, so that risk managers could hedge their exposure to weather risk. After a slow start the weather derivatives market have started to grow rapidly. Risk managers can no longer blame poor financial results on the weather. Weather risk can be removed by hedging. This thesis will explain briefly what a derivative is and point out some motives for use of derivatives. Thereafter we will look at the history of the weather risk market, how the weather risk market has developed in recent years and also who the current and potential players in the weather risk market are. The most famous methods for valuation of weather derivatives will also be introduced and discussed. Finally problems and possibilities of the weather derivative market will be briefly discussed. After the general part about weather derivatives a case study will be conducted on the Norwegian brewery Ringnes AS. First several regressions are run to model the relation between beverage sales and temperature. Next the chosen model is used to decide the relation for a given period of time. After the relation between sales and temperatures is analysed, appropriate hedging strategies are discussed. Some chosen hedging strategies will be evaluated by use of common weather derivative valuation methods. Finally these analyses form the foundation for a conclusion whether or not Ringnes AS should implement weather derivatives in their risk management strategy.