A new study has proposed a methodology for identifying effective hedging strategies based on weather derivatives.
Research by Cass Business School academics has presented a methodology for identifying how winter tourism operators can protect themselves against the risk of decreasing visitor numbers to ski destinations and lost revenues.
Due to the effects of climate change, ski tourism in the Alps is becoming endangered by decreasing levels of snow caused by rising winter temperatures.
Focusing on the use of weather derivatives as a means of revenue protection, the study uses a series of models to design useful weather derivatives payoff – where operators sell risk to financial markets for a premium by predicting visitor numbers and revenues in a given month, according to a statement.
The methodology is based on more than 50 years’ worth of snowfall and temperature data recorded at a resort in Austria.
Reliance on public holidays
Among the key findings are that visitor numbers to resorts vary considerably within the ski season itself, depending on snow depth and temperature. As snow depth decreases, companies become more heavily reliant on the traditionally busier days, such as Christmas Day and other public holidays, school holidays and weekends.
Furthermore, greater depths of snow on the first day of a ski season reduce the dependence of these popular days for visitors to provide revenues – showing that snowfall and temperature consistency is important out of season as well as in it, according to the statement.
Due to the variation of visitor numbers, financial markets and winter tourism operators should base weather derivative contracts on historical average monthly revenues, fluctuating strike prices every month to form different contracts for each. On the other hand, a single contract based on cumulative snow fall at the season end is highly risky for all parties and attracts the highest profit and loss variance out of all options that were tested.
Figures from the study included 20,774 historic daily weather observations of Sonnblick, Austria, from the European Climate Assessment (ECA), with the assumption that a ski season runs annually from 1 December through to 15 April. A ‘100-day’ rule is used as a critical threshold for visitor numbers, with the study considering 30cm of snow for at least 100 days during the winter season as a minimum requirement for testing reliability of ski operations.
Purchase weather derivatives
Co-author Dr Laura Ballotta, Reader in Financial Mathematics at Cass Business School, said the report’s findings should encourage ski tourism companies to purchase weather derivatives and think more strategically about the risk involved.
“Treatment of premises through artificial ‘snowmaking’ and landscaping is costly and could release potentially harmful additives into the environment. Diversifying activities beyond traditional ski and snow sports activities can also have expensive investment costs, so we believe that accessing financial markets for weather derivatives and sharing risk is the most viable option,” she said.
She added: “Winter tourism is vital to Alpine regions, not just in terms of snow sport facilities but also accommodation, catering, entertainment and retail opportunities that come with it. Higher temperatures are reducing snow levels each year, which could have major ramifications on tourism to an area that depends so heavily on the revenues it generates.
“By using our methodology based on more than 50 years’ worth of snowfall and temperature data, companies can optimise weather derivative contracts to protect themselves from financial ruin if snow levels are insufficient.”