Global warming index

Investment bank UBS is trying to change weather investing by launching the first Global Warming Index (GWI), which provides a simple way to take a view on a wide range of weather variables. While initially linked to the temperature of several US cities, there are plans to add European and Asian ones soon. In fact, as UBS notes, there is no limit in principle to the number of cities to be included as references. In this sense, the UBS index would truly capture global phenomena in one stroke.

Thanks to this pioneering development, it is now possible to bet on whether Global Warming is true or false. If you believe the direst predictions will hold true and a persistent upward trend in global (or, at least for now, US) temperatures will become the norm, you would buy the Index (which goes up with the underlying temperature). If you think Mr Gore an alarmist sensationalist, you would sell the Index.

In common with equity, foreign exchange or interest rate underlyings, it is possible to devise structured products based on the GWI. For instance, rather than park money in a low-yielding savings account, an investor could instead enter into a weather-related guaranteed investment or a weather-related note, where returns would depend on the average quarterly performance of the Index. In essence, the warmer the globe gets (as measured by the GWI) the higher the return.

Most interesting are the opportunities to engineer basket, or diversified, structures around the GWI. In these exotic deals, the investor's return would depend directly on the (most likely, purely coincidental rather than direct) correlation between weather and one, two, or more different asset classes.

GWI-based basket trades could help investors in traditional assets to diversify (hedge) their positions via the addition of a non-correlated new variable. Given how closely correlated markets can be from time to time, it may not be a bad idea to include some weather in an old-fashioned menu. If anything, the GWI could be seen as a cheaper (not to mention more exciting) alternative to protecting returns through the use of same-family derivatives (such as equity options or currency forwards).

From http://en.wikipedia.org/