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Securitizing peanut production risk with catastrophe (CAT) bonds

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  • Epperson, James E.

Abstract

A catastrophe (CAT) bond is designed for peanut production as a means of transferring natural disaster risks from insurance purveyors to the global capital market. The CAT bond so designed is priced using state-level historical yields for peanut production in the southern part of the United States in the State of Georgia. The index triggering the CAT bond contract was based on percent deviation from state average yield. The principal finding of the study is that it appears feasible for crop insurance purveyors to issue insurance-linked securities. CAT bonds can reduce the variance of the loss ratio when issued optimally with regard to the number of bonds and contract specifications. CAT bonds could therefore be used in hedging catastrophic risk effectively in peanut production given that crop insurance purveyors normally seek to minimize the variance of the loss ratio. CAT bonds were found to be feasible as hedging instruments even in the range of normal losses commonly covered by crop insurance and reinsurance.

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Bibliographic Info

Paper provided by University of Georgia, Department of Agricultural and Applied Economics in its series Faculty Series with number 44512.

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Date of creation: 31 Oct 2008
Date of revision:
Handle: RePEc:ags:ugeofs:44512

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Keywords: Insurance; Reinsurance; Pricing; Hedging; Agricultural Finance; Crop Production/Industries; Risk and Uncertainty;

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References

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  1. Neil A. Doherty, 1997. "Financial Innovation in the Management of Catastrophe Risk," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(3), pages 84-95.
  2. Cummins, J. David & Lalonde, David & Phillips, Richard D., 2004. "The basis risk of catastrophic-loss index securities," Journal of Financial Economics, Elsevier, vol. 71(1), pages 77-111, January.
  3. Jerry R. Skees & J. Roy Black & Barry J. Barnett, 1997. "Designing and Rating an Area Yield Crop Insurance Contract," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 79(2), pages 430-438.
  4. 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.
  5. J. David Cummins & Christopher M. Lewis & Richard D. Phillips, 1998. "Pricing Excess-of-loss Reinsurance Contracts Against Catastrophic Loss," Center for Financial Institutions Working Papers 98-09, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. Neil A. Doherty, 1997. "Financial Innovation in the Management of Catastrophe Risk," Center for Financial Institutions Working Papers 98-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Baquet, Alan E. & Skees, Jerry R., 1994. "Group Risk Plan Insurance: An Alternative Management Tool for Farmers," Choices, Agricultural and Applied Economics Association, vol. 9(1).
  8. Vedenov, Dmitry V. & Epperson, James E. & Barnett, Barry J., 2006. "Designing Catastrophe Bonds to Securitize Systemic Risks in Agriculture: The Case of Georgia Cotton," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 31(02), August.
  9. Vedenov, Dmitry V. & Barnett, Barry J., 2004. "Efficiency of Weather Derivatives as Primary Crop Insurance Instruments," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 29(03), December.
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