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On the Systemic Nature of Weather Risk

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  • Xu, Wei
  • Filler, Gunther
  • Odening, Martin
  • Okhrin, Ostap

Abstract

Systemic weather risk is a major obstacle for the formation of private (nonsubsidized) crop insurance. This paper explores the possibility of spatial diversification of insurance by estimating the joint occurrence of unfavorable weather conditions in different locations. For that purpose copula methods are employed that allow an adequate description of stochastic dependencies between multivariate random variables. The estimation procedure is applied to weather data in Germany. Our results indicate that indemnity payments based on temperature as well as on cumulative rainfall show strong stochastic dependence even at a national scale. Thus the possibility to reduce risk exposure by increasing the trading area of the insurance is limited. Irrespective of their economic implications our results pinpoint the necessity of a proper statistical modeling of the dependence structure of multivariate random variables. The usual approach of measuring stochastic dependence with linear correlation coefficients turned out to be questionable in the context of weather insurance as it may overestimate diversification effects considerably.

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Bibliographic Info

Paper provided by Agricultural and Applied Economics Association in its series 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin with number 49131.

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Date of creation: 2009
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Handle: RePEc:ags:aaea09:49131

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Keywords: weather risk; crop insurance; copula; Risk and Uncertainty; C14; Q19;

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References

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  1. Vedenov, Dmitry V., 2008. "Application of Copulas to Estimation of Joint Crop Yield Distributions," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6264, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  2. Markus Junker & Angelika May, 2005. "Measurement of aggregate risk with copulas," Econometrics Journal, Royal Economic Society, vol. 8(3), pages 428-454, December.
  3. Mario J. Miranda & Joseph W. Glauber, 1997. "Systemic Risk, Reinsurance, and the Failure of Crop Insurance Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 79(1), pages 206-215.
  4. Xu, Wei & Odening, Martin & Musshoff, Oliver, 2008. "Optimal Design of Weather Bonds," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6781, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  5. repec:sae:ecolab:v:16:y:2006:i:2:p:1-2 is not listed on IDEAS
  6. Wolfgang Härdle & Ostap Okhrin & Yarema Okhrin, 2008. "Modeling Dependencies in Finance using Copulae," SFB 649 Discussion Papers SFB649DP2008-043, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  7. Enzo Giacomini & Wolfgang Härdle, 2005. "Value-at-Risk Calculations with Time Varying Copulae," SFB 649 Discussion Papers SFB649DP2005-004, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  8. H. Holly Wang & Hao Zhang, 2003. "On the Possibility of a Private Crop Insurance Market: A Spatial Statistics Approach," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(1), pages 111-124.
  9. World Bank, 2005. "Managing Agricultural Production Risk : Innovations in Developing Countries," World Bank Other Operational Studies 14434, The World Bank.
  10. Barry K. Goodwin, 2001. "Problems with Market Insurance in Agriculture," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(3), pages 643-649.
  11. Martin Odening & Oliver Musshoff & Wei Xu, 2007. "Analysis of rainfall derivatives using daily precipitation models: opportunities and pitfalls," Agricultural Finance Review, Emerald Group Publishing, vol. 67(1), pages 135-156, May.
  12. Martin, Steven W. & Barnett, Barry J. & Coble, Keith H., 2001. "Developing And Pricing Precipitation Insurance," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 26(01), July.
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Citations

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Cited by:
  1. Bokusheva, Raushan, 2010. "Measuring the dependence structure between yield and weather variables," MPRA Paper 22786, University Library of Munich, Germany.
  2. Roland Strausz, 2010. "The Political Economy of Regulatory Risk," CESifo Working Paper Series 2953, CESifo Group Munich.
  3. Ritter, Matthias & Musshoff, Oliver & Odening, Martin, 2012. "Minimizing geographical basis risk of weather derivatives using a multi-site rainfall model," 123rd Seminar, February 23-24, 2012, Dublin, Ireland 122527, European Association of Agricultural Economists.
  4. Michał Grajek & Lars-Hendrik R�ller, 2012. "Regulation and Investment in Network Industries: Evidence from European Telecoms," Journal of Law and Economics, University of Chicago Press, vol. 55(1), pages 189 - 216.
  5. Shen, Zhiwei & Odening, Martin, 2012. "Coping with Systemic Risk in Index-based Crop Insurance," 123rd Seminar, February 23-24, 2012, Dublin, Ireland 122555, European Association of Agricultural Economists.
  6. Ostap Okhrin, 2010. "Fitting high-dimensional Copulae to Data," SFB 649 Discussion Papers SFB649DP2010-022, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  7. Raushan Bokusheva, 2011. "Measuring dependence in joint distributions of yield and weather variables," Agricultural Finance Review, Emerald Group Publishing, vol. 71(1), pages 120-141, May.
  8. 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.
  9. Maria Grith & Wolfgang Härdle & Juhyun Park, 2009. "Shape invariant modelling pricing kernels and risk aversion," SFB 649 Discussion Papers SFB649DP2009-041, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  10. Schulte-Geers, Matthias & Berg, Ernst, 2011. "Modelling farm production risk with copulae instead of correlations," 2011 International Congress, August 30-September 2, 2011, Zurich, Switzerland 115996, European Association of Agricultural Economists.
  11. Barbara Choroś & Wolfgang Härdle & Ostap Okhrin, 2009. "CDO and HAC," SFB 649 Discussion Papers SFB649DP2009-038, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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