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    WeRiManage Project

    Weather may influence the financial performance of many industries, local government and households. It has been reported that weather impacts one third of the economy while weather effects may determine in the US a change in monthly employment data by more than 100,000 in either direction. Furthermore, uncertainty around climate legislation should be understood to be an increasingly important risk factor, with the potential to greatly affect government’s expenditure and decision-making, corporate profits and investors’ financial returns.

    Financial markets play several important roles in addressing climate change, Bolton & Kacperczyk (2021):
    1. Provide information and important inputs for economic and policy decisions (mitigation, adaptation, monitoring)
    2. Allocation of funds to sustainable investments and promoting technological transition (mitigation)
    3. Managing and sharing climate risks (adaptation)

    The goal of this project is to address various problems around climate and weather risk with the use of climate derivatives – also known and as weather derivatives – a class of financial assets, and the role they play in determining how finance can contribute to a solution to the following questions:
    1. Are climate risks reflected in asset prices? By how much? (monitoring)
    2. How can we use financial markets to hedge or share climate risks? (adaptation)
    How can information from financial markets be useful for climate decision-making?

    The weather market was a fast-developing market. According to the Weather Risk Management Association the market grew by 20% in 2010–2011, to a total notional value of $11.8 billion, and further understanding of the uncertainty about weather trends or increased variability will enhance even further its expansion. However, after the financial crisis of the 2008 the market has become stagnant, greatly affected by liquidity and has undertaken a move toward OTC trading. Currently, there are three main problems affecting the weather market:

    1. There is a need for more advanced weather assets currently not trading in the weather market. Current contracts, which are focused only on daily temperature, do not necessarily correspond to firm needs. The reality of the professionals needing weather derivatives very often goes beyond the standardization of products offered in markets such as the CME. The OTC market could provide the required customization of trades, but OTC trades require higher premiums and generate counterparty risk. Given this vicious circle of risk, few accept OTC trades. OTC trades also face asset valuation challenges, require special audit treatment and trigger additional regulatory requirements.
    2. Another barrier to entry into the weather derivatives market is the complexity of these products and the absence of a general accepted pricing model. Moreover, weather derivatives are often explained poorly to those who are not experienced financial market professionals. Investing in weather derivatives may prove to be a costly and ill-informed decision for these participants.
    3. Most weather sensitive companies are not aware of the benefits that the weather market can offer. Interview with 61 ski lift operators in Austria indicate that while the majority of operators are aware of weather risks and report substantial weather exposure, using weather derivatives as a means of offsetting potential loss is rarely considered. This is primarily due to a lack of awareness and knowledge, Bank & Wiesner (2011). The task is thus to increase awareness, knowledge and support for the weather sensitive firms with reference to the use of weather derivatives

    The WeRiManage project aims to address these three important challenges by offering a complete Weather Risk Management Framework. The WeRiManage project consists of three main axes.

    1) We propose a novel pricing framework, which is not computationally intensive and it is easy to grasp, for weather derivatives and related products in correlated markets such as energy and CO2.

    2) We design a new class of financial assets, tailored to the needs of the weather sensitive companies and develop the corresponding pricing and risk-management framework.

    3) We contribute to the financial literacy of investors by studying how companies are affected by weather and climate, whether the boards of these companies understand the weather risk, and whether they take any actions to mitigate these risks.

    Our results will ease of access and improvements in the understanding of these products, which would foster greater interest. If the market attains good levels of depth and liquidity, insurers could also recognize an opportunity for them to hedge the risk they themselves take to insure companies facing climate risk.