Pricing and Hedging of Weather and Freight Derivatives: Analysis of the Post-Pandemic Situation

Introduction

The covid-19 pandemic period has shown its impact on various sectors across the globe. It is known that the entire world faced several hurdles due to phase-wise lockdown during 2020-2021. At the same time the business organizations faced problems in the shipment of their products during this period. The present fluctuations in the pricing of logistics and supply-chain have shown major impact on profitability. Hence, this situation raised the need to assess the impact of derivatives with respect to weather and freight derivatives.

Objectives

• 1.

  To understand the empirical research on weather and freight derivatives in a global context.

• 2.

  To make aware of mathematical models and theories of derivative pricing.

• 3.

  To study impact of pandemic on logistics particularly weather and freight derivatives.

This chapter is organized into the following sections to achieve aforesaid objectives:

• •

  Genesis of Derivatives,

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  Background and Review of Literature,

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  Main Focus of the Chapter,

• •

  Mathematical models of pricing derivatives

• •

  Solutions and Recommendations

• •

  Future Research Direction,

• •

  Conclusions.

Genesis Of Derivatives

Achilleas and Antonis (2013) study states that the “weather derivatives are financial contracts whose payoff depends on the underlying weather variable(s). The underlying weather variables can be temperature, precipitation, snowfall, humidity, or wind. These instruments differ from other derivatives because the underlying asset has no value and cannot be stored. Thus, these weather variables are indexed to make them tradable like other index products such as stock indexes. For example, quantification is how much the temperature deviates from daily, monthly, or a seasonal average temperature in a particular city or region. The variations are then adjusted to indexes with a currency amount attached to each index point”.

It is opined that trading has been lifestyle during of the twelfth century in England and France. The process of buying and selling rice began during the seventeenth century referred to as ‘Cho-at-Mai’ (rice exchange-on-book) done in Japan. In 1730, this marketplace was given a legit reputation from the Tokugawa Shogunate. In 1874, the Chicago Commodities Exchange became established, imparting butter, eggs, poultry, and different consumable agricultural products. The Chicago Commodities Exchange withdrawn the products butter and in 1898. This exchange re-established with new title ‘The Chicago Mercantile Exchange (CME)” for derivatives market in 1919. This exchange furnished a futures marketplace for plenty of commodities during 1961-71 viz., red meat, stay livestock, stay hogs, and feeder cattle. Many different exchanges in this sector now doing in business of ‘futures contracts’. At the American Civil War period (1860 to 1865) it has become a routine activity to trade with such agreements wherein actual transport of produce become unnecessary. The London Metal Exchange entered into Commodities trading, and today, its miles the foremost marketplace in metallic buying and selling. During 1980s, markets evolved for alternatives in options on inventory indices, and options on futures contracts.