Hedging Crop Yields Against Weather Uncertainties—A Weather Derivative Perspective

Abstract

The effects of weather on agriculture in recent years have become a major global concern. Hence, the need for an effective weather risk management tool (i.e., weather derivatives) that can hedge crop yields against weather uncertainties. However, most smallholder farmers and agricultural stakeholders are unwilling to pay for the price of weather derivatives (WD) because of the presence of basis risks (product-design and geographical) in the pricing models. To eliminate product-design basis risks, a machine learning ensemble technique was used to determine the relationship between maize yield and weather variables. The results revealed that the most significant weather variable that affected the yield of maize was average temperature. A mean-reverting model with a time-varying speed of mean reversion, seasonal mean, and local volatility that depended on the local average temperature was then proposed. The model was extended to a multi-dimensional model for different but correlated locations. Based on these average temperature models, pricing models for futures, options on futures, and basket futures for cumulative average temperature and growing degree-days are presented. Pricing futures on baskets reduces geographical basis risk, as buyers have the opportunity to select the most appropriate weather stations with their desired weight preference. With these pricing models, farmers and agricultural stakeholders can hedge their crops against the perils of extreme weather.

Modeling Asymmetric Volatility: A News Impact Curve Approach

“…A proper understanding of price fluctuations can be helpful for producers to make the appropriate decision at the right time to minimize their financial losses. Weather derivatives [38] can be used to mitigate the jeopardy of weather uncertainties. Predicting asymmetric price volatility may be taken into consideration in future research.…”

Construction of Mixed Derivatives Strategy for Wind Power Producers

“…In particular, weather derivatives are extremely useful for hedging energy market-related risks, and in recent years, there have been a large number of applications in both practical and research contexts [6]. Moreover, pricing methods and specific applications of weather derivatives are presented in several pieces of literature [7][8][9][10], where previous studies have been mainly related to weather derivatives on a single underlying index such as temperature [11][12][13][14][15][16], but also solar radiation/irradiation [17,18] and rainfall [19]. In the context of wind power businesses, the recent increase in hedging needs, coupled with the increased demand for wind power to achieve decarbonization goals, has led to recent studies on wind derivatives.…”

Option pricing of weather derivatives based on a stochastic daily rainfall model with Analogue Year component

“…do have great impact on the farming activities of these farmers [5]. Thus, an effective and reliable risk management tool, weather derivative (WD) is needed to hedge farmers and stakeholders from the risk of weather uncertainties.…”

“…Thus, an effective and reliable risk management tool, weather derivative (WD) is needed to hedge farmers and stakeholders from the risk of weather uncertainties. By linking the payoffs to a fairly measured weather indices (e.g., temperature, rainfall, humidity, Sunshine), weather derivative reduces or eliminates the downside of traditional insurance [5]. Weather derivatives, unlike traditional derivatives, have no underlying tradable instrument or stock.…”