Hedging Risk with Derivatives in the Rain-Sensitive Hospitality Industry

Abstract

Weather is a fundamental resource for tourism, but adverse meteorological events (such as persistent rain) need to be considered by hospitality firms because of the increasing economic damages they cause. The study adds to the weather derivative and tourism literature by advancing a model for the rainfall risk management of hospitality firms. It aims to show, in two steps, how hospitality firms could share the risks caused by rain with counterparties by adopting a rainfall derivative to mitigate the negative impacts of rain on profitability. In particular, the first step of the proposed model is based on scenario correlation between business performances and rain. The second step introduces rainfall derivatives and analyzes their impact on the earnings before interest and taxes of hospitality firms. The model is supported by a numerical application covering the decade 2005 to 2014 and based on the business performances of 25 hotels located on Lake Garda, Italy and on the amount of rainfall on that lake.