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Modeling and Pricing Rain Risk

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Author Info
Musshoff, Oliver
Odening, Martin
Xu, Wei

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Abstract

In this paper we price a precipitation option based on empirical weather data from Germany using different pricing methods, among them Burn Analysis, Index Value Simulation and Daily Simulation. For that purpose we develop a daily precipitation model. Moreover, a decorrelation analysis is proposed to assess the spatial basis risk that is inherent to rainfall derivatives. The models are applied to precipitation data in Brandenburg, Germany. Based on simplifying assumptions of the production function, we quantify and compare the risk exposure of grain producers with and without rainfall insurance. It turns out that a considerable risk remains with producers who are remotely located from the weather station. Another finding is that significant differences may occur between the pricing methods. We identify the strengths and weaknesses of the pricing methods and give some recommendations for their applications. Our results are relevant for producers as well as for potential sellers of weather derivatives.

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Publisher Info
Paper provided by International Association of Agricultural Economists in its series 2006 Annual Meeting, August 12-18, 2006, Queensland, Australia with number 25386.

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Date of creation: 2006
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Handle: RePEc:ags:iaae06:25386

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Related research
Keywords: weather risk; weather derivatives; precipitation model; basis risk; Resource /Energy Economics and Policy; Risk and Uncertainty; C8; Q14; Q54;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Timothy J. Richards & Mark R. Manfredo & Dwight R. Sanders, 2004. "Pricing Weather Derivatives," American Journal of Agricultural Economics, American Agricultural Economics Association, vol. 86(4), pages 1005-1017, November. [Downloadable!] (restricted)
  2. Richards, Timothy J. & Manfredo, Mark R. & Sanders, Dwight R., 2004. "Pricing Weather Derivatives," Working Papers 28536, Arizona State University, Morrison School of Agribusiness and Resource Management. [Downloadable!]
  3. Peter Alaton & Boualem Djehiche & David Stillberger, 2002. "On modelling and pricing weather derivatives," Applied Mathematical Finance, Taylor and Francis Journals, vol. 9(1), pages 1-20, March. [Downloadable!] (restricted)
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  1. Carter, Chris & Crean, Jason & Kingwell, Ross & Hertzler, Greg, 2006. "Managing and Sharing the Risks of Drought in Australia," 2006 Annual Meeting, August 12-18, 2006, Queensland, Australia 25319, International Association of Agricultural Economists. [Downloadable!]
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