Defining parameters of an underlying variable (asset/value) and establishing water table as underlying value

• Published in: Finance India 2002-12, Vol.16 (4), p.1273
• Main Author: Agarwal, Aman
• Format: Article
• Language: English
• Subjects: Annual reports; Derivatives; Economic development; Energy; Financial instruments; Futures; Hedging; Options markets; Rain; Stock exchanges; Variables; Weather
• ISSN: 0970-3772

Derivative instruments (DI) derive their value from the underlying variable (UV). With the introduction of weather derivative instruments (WDI) the UV widened its range from just including underlying asset to underlying values. Underlying asset are easy to identify and price as compared to the values, due to their tangible nature. Hence, the issue of laying down parameters to determine the UVs was not addressed before. The question of whether a value or an asset can be considered as an underlying variable for a DI is pertinent and vital. This article formulates the boundaries for an UV (asset/value). The underlying value as an underlying variable was introduced in 1997 with the introduction of the first weather derivative instrument embedded in an energy contract. The values which are established due to needs and instrumentation by markets are: 1. temperature, 2. rainfall, 3. snowfall, and 4. precipitation. This article also establishes the newly developed value - Water Table as an underlying variable for WDIs.