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Volume
68, Number 1, Spring 2008 Papers "A Bayesian Approach to German Agricultural Yield Expectations" authored by Jette Krause Abstract
Key words: biophysical modeling, climate change, crop production functions, crop yields, robust estimation, yield variation "Revisiting the Demand for Agricultural Insurance: The Case of Spain" authored by
Alberto Garrido and David Zilberman "Hedging with Weather Derivatives to Cope with Climate Variability and Change in Grain Maize Production" authored by Daniele Simone Torriani, Pierluigi Calanca, Martin Beniston, and Jürg Fuhrer "Portfolio Effects and the Willingness to Pay for Weather Insurances" authored by Oliver Musshoff, Norbert Hirschauer, and Martin Odening Since the mid-1990s, agricultural economists have discussed the relevance of index-based insurances, also called “weather derivatives,” as hedging instruments for volumetric risks in agriculture. Motivated by the question of how weather derivatives should be priced for agricultural firms, this paper describes an extended risk-programming model which can be used to determine farmers’ willingness to pay (demand function) for weather derivatives. The model considers both the derivative’s farm-specific risk-reduction capacity and the individual farmer’s risk acceptance. Applying it to the exemplary case of a Brandenburg farm reveals that even a highly standardized contract which is based on the accumulated rainfall at the capital’s meteorological station in Berlin-Tempelhof generates a relevant willingness to pay. Our findings suggest that a potential underwriter could even add a loading on the actuarially fair price which exceeds the level of traditional insurances. Since transaction costs are low compared to insurance contracts, this finding indicates there may be a relevant trading potential. Key words: production program planning under risk, rainfall risk, weather derivatives, willingness to pay
"Basis Risk and Weather Hedging Effectiveness" authored by Joshua D. Woodard and Philip Garcia Basis risk—the risk that payoffs of a hedging instrument do not correspond to the underlying exposure—is cited as a primary concern for implementing weather hedges. Using Illinois yields and weather data, we investigate several dimensions of weather basis risk in the U.S. corn market. Results suggest that while geographic basis risk can be significant, it should not preclude the use of geographic cross-hedging, particularly with temperature as opposed to precipitation derivatives. Risk reduction is appreciable and the degree to which geographic basis risk impedes effective hedging diminishes as spatial aggregation in the risk exposure and hedging instrument increases. Key words: basis risk, hedging effectiveness, spatial aggregation, weather derivatives
"Weather-Based Instruments in the Context of Whole-Farm Risk Management" authored by Ernst Berg and Bernhard Schmitz Basis risk—the risk that payoffs of a hedging instrument do not correspond to the underlying exposure—is cited as a primary concern for implementing weather hedges. Using Illinois yields and weather data, we investigate several dimensions of weather basis risk in the U.S. corn market. Results suggest that while geographic basis risk can be significant, it should not preclude the use of geographic cross-hedging, particularly with temperature as opposed to precipitation derivatives. Risk reduction is appreciable and the degree to which geographic basis risk impedes effective hedging diminishes as spatial aggregation in the risk exposure and hedging instrument increases. Key words: basis risk, hedging effectiveness, spatial aggregation, weather derivatives
"The Pricing, Structure, and Function of Weather-Linked Bonds, Mortgages, and Operating Credit" authored by Calum G. Turvey This paper outlines approaches to valuating weather-linked bonds, mortgages, and operating lines of credit. Using historical data from weather stations in Ardmore, Oklahoma, and Ithaca, New York, indemnities and insurance premiums are computed for specific-event rainfall insurance. The main contribution of the paper is the development of new and accurate formulae for determining the coupon rates on weather-linked bonds and the interest rates on weather-linked mortgages and lines of credit. The empirical aspects of the paper indicate that linking weather risk to debt may be very costly if the risks are common, but the risk premiums on rare or low-frequency weather risks can be very manageable. Key words: precipitation insurance, rainfall insurance, weather derivatives, weather insurance, weather-linked bonds, weather-linked mortgages"Creating Insurance Markets for Natural Disaster Risk in Lower Income Countries: The Potential Role for Securitization" authored by Jerry R. Skees, Barry J. Barnett, and Anne G. Murphy This article considers the potential for securitizing index-based insurance products that transfer weather and natural disaster risks from lower income countries. It begins with a brief overview explaining why markets for natural disaster risks are important, yet often missing, in lower income countries and a review of some recent activities using index-based weather insurance. Next, we describe how natural disaster risks are handled in higher income countries. These examples, along with the example of an innovative index-based livestock insurance pilot project in Mongolia, illustrate how layers, or tranches, of natural disaster risk can be financed during the product development phase by creating structures similar to the Special Purpose Vehicles used in catastrophe bond, mortgage bond, and the emerging microfinance bond markets. We refer to these investment alternatives as micro-CAT bonds since the principal amounts would be small relative to the existing CAT bond market. Key words: catastrophe risk, index insurance, reinsurance, socially responsible investing, weather risks"Improving Humanitarian Response to Slow-Onset Disasters Using Famine-Indexed Weather Derivatives" authored by Sommarat Chantarat, Calum G. Turvey, Andrew G. Mude, and Christopher B. Barrett This paper illustrates how weather derivatives indexed to forecasts of famine can be designed and used by operational agencies and donors to facilitate timely and reliable financing for effective emergency response to climate-based, slow-onset disasters such as drought. We provide a general framework for derivative contracts, especially in the context of index insurance and famine catastrophe bonds, and show how they can be used to complement existing tools and facilities in drought risk financing through a risk-layering strategy. We use the case of arid lands of northern Kenya, where rainfall proves a strong predictor of widespread and severe child wasting, to provide a simple empirical illustration of the potential contract designs. Key words: catastrophe bond, covariate risk, famine relief, food aid, food insecurity, Kenya, pastoralists, weather derivatives"Challenges for Use of Index-Based Weather Insurance in Lower Income Countries" authored by Jerry R. Skees This article offers some perspective on the progress and challenges of managing catastrophic weather risk in lower income countries through the use of index insurance. Innovations in insurance for natural disaster risk are critically important to help the rural poor improve their lives and to contribute to the overall economic growth in lower income countries. By reviewing lessons learned from various index insurance projects, several conclusions are made about how best to approach weather risk management to benefit the livelihoods of the rural poor. It is important to recognize the limitations of index insurance and that it is not a substitute for crop insurance. However, using index insurance to address catastrophic risk can serve as the foundation for the development of broader financial services by removing one of the major constraints to market development. This in turn can offer households more effective strategies for consumption smoothing in the face of different sources and magnitudes of risk. Key words: ex ante risk management, index insurance, risk transfer, rural development, weather riskAbstracts "Using Participating and Financial Contracts to Insure Catastrophe Risk: Implications for Crop Risk Management" authored by Geoffroy Enjolras and Robert Kast "Creating Safety Nets Through Semi-parametric Index-Based Insurance: A Simulation for Northern Ghana" authored by Vasco Molini, Michiel Keyzer, Bart van den Boom, and Wouter Zant
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