A weather derivative that involves a nonfinancial or nonphysical asset, literally a weather index, and whereby one counterparty is committed to make payment to the other if the number of degree days over a pre-determined period exceeds a preset level, while the other will be required to make payment if the number of degree days is below that level. Weather swaps, thus, allow weather-affected companies and utilities to hedge risks associated with heating or cooling expenses or other business risks related to temperature or weather volatility.
This swap is also known as a temperature swap.
