What is the definition of Weather Derivative?

A Weather Derivative is a security or financial instrument that uses weather as a hedge. These are commonly used by businesses that are energy-related and also by those whose sales are considerably affected by the weather. For instance, theme parks can use weather derivatives to protect against rainy weekends that occur during the summer (the peak season for theme parks). Farmers may also use derivatives to protect against frost or draught that will cause poor harvests.

This is one way that an individual or organization can manage and reduce the risk that is connected with unexpected or unfavorable weather conditions. Unlike other derivatives, the price of the weather derivative and its underlying asset (snow, temperature or rain) may not correspond with price.

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