Hedging weather risk on aggregated and individual farm-level: Pitfalls of aggregation biases on the evaluation of weather index-based insurance
AbstractPurpose – Since the 1990s, there has been a discussion about the use of weather index-based insurance, also called weather derivatives, as a new instrument to hedge against volumetric risks in agriculture. It particularly differs from other insurance schemes by pay-offs being related to objectively measurable weather variables. Due to the absence of individual farm yield time series, the hedging effectiveness of weather index-based insurance is often estimated on the basis of aggregated farm data. The authors expect that there are differences in the hedging effectiveness of insurance on the aggregated level and on the individual farm-level. The purpose of this paper is to estimate the magnitude of bias which occurs if the hedging effectiveness of weather index-based insurance is estimated on aggregated yield data. Design/methodology/approach – The study is based on yield time series from individual farms in central Germany and weather data provided by the German Meteorological Service. Insurance is structured as put-option on a cumulated precipitation index. The analysis includes the estimation of the hedging effectiveness of insurance on aggregated level and on individual farm-level. The hedging effectiveness is measured non-parametrically regarding the relative reduction of the standard deviation and the value at risk of wheat revenues. Findings – Findings indicate that the hedging effectiveness of a weather index-based insurance estimated on aggregated level is considerably higher than the realizable hedging effectiveness on the individual farm-level. This refers to: hedging effectiveness estimated on the aggregated level is higher than the mean of realized hedging effectiveness on the individual farm-level and almost every evaluated individual farm in the analysis realizes a lower hedging effectiveness than estimated on the aggregated level of the study area. Nevertheless, weather index-based insurance designed on the aggregated level can lead to a notable risk reduction for individual farms. Originality/value – To the authors’ knowledge, this paper is the first that analyzes the influence of crop yield aggregation with regard to the hedging effectiveness of weather index-based insurance.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Emerald Group Publishing in its journal Agricultural Finance Review.
Volume (Year): 72 (2012)
Issue (Month): 3 (September)
Contact details of provider:
Web page: http://www.emeraldinsight.com
Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Louise Lister).
If references are entirely missing, you can add them using this form.