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Basis risk and weather hedging effectiveness

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  • Jason D. Woodard
  • Philip Garcia
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    Abstract

    Basis risk – the risk that payoffs of a hedging instrument do not correspond to the underlying exposures – is cited as a primary concern for implementing 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.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Agricultural Finance Review.

    Volume (Year): 68 (2008)
    Issue (Month): 1 (September)
    Pages: 99-117

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    Handle: RePEc:eme:afrpps:v:68:y:2008:i:1:p:99-117

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    Related research

    Keywords: Basis risk; Hedging effectiveness; Spatial aggregation; Weather derivatives;

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    Cited by:
    1. Buchholz, Matthias & Musshoff, Oliver, 2014. "The role of weather derivatives and portfolio effects in agricultural water management," 2014 Conference (58th), February 4-7, 2014, Port Maquarie, Australia 165812, Australian Agricultural and Resource Economics Society.
    2. M. Ritter & O. Mußhoff & M. Odening, 2014. "Minimizing Geographical Basis Risk of Weather Derivatives Using A Multi-Site Rainfall Model," Computational Economics, Society for Computational Economics, vol. 44(1), pages 67-86, June.
    3. Hardaker, J. Brian & Lien, Gudbrand, 2010. "Probabilities for decision analysis in agriculture and rural resource economics: The need for a paradigm change," Agricultural Systems, Elsevier, vol. 103(6), pages 345-350, July.

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