DEFINITION of 'Weather Derivative'

An instrument used by companies to hedge against the risk of weather-related losses. The investor who sells a weather derivative agrees to bear this risk for a premium. If nothing happens, the investor makes a profit. However, if the weather turns bad, then the company who buys the derivative claims the agreed amount.

BREAKING DOWN 'Weather Derivative'

This is not the same as insurance, which is for low-probability events like hurricanes and tornados. In contrast, derivatives cover high-probability events like a dryer-than-expected summer.

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