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On the systemic nature of weather risk

  • Wei Xu
  • Guenther Filler
  • Martin Odening
  • Ostap Okhrin

Purpose – The purpose of this paper is to assess the losses of weather-related insurance at different regional levels. The possibility of spatial diversification of insurance is explored by estimating the joint occurrence on unfavorable weather conditions in different locations, looking particularly at the tail behavior of the loss distribution. Design/methodology/approach – Joint weather-related losses are estimated using copulas. Copulas avoid the direct estimation of multivariate distributions but allow for much greater flexibility in modeling the dependence structure of weather risks compared with simple correlation coefficients. Findings – Results indicate that indemnity payments based on temperature as well as on cumulative rainfall show strong stochastic dependence even at a large regional scale. Thus the possibility to reduce risk exposure by increasing the trading area of insurance is limited. Research limitations/implications – The empirical findings are limited by a rather weak database. In that case the estimation of high-dimensional copulas leads to large estimation errors. Practical implications – The paper includes implications for the quantification of systemic weather risk which is important for the rate making of crop insurance and reinsurance. Originality/value – This paper's results highlight how important the choice of the statistical approach is when modeling the dependence structure of weather risks.

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

Volume (Year): 70 (2010)
Issue (Month): 2 (August)
Pages: 267-284

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Handle: RePEc:eme:afrpps:v:70:y:2010:i:2:p:267-284
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  1. 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.
  2. 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).
  3. Markus Junker & Angelika May, 2005. "Measurement of aggregate risk with copulas," Econometrics Journal, Royal Economic Society, vol. 8(3), pages 428-454, December.
  4. World Bank, 2005. "Managing Agricultural Production Risk : Innovations in Developing Countries," World Bank Other Operational Studies 14434, The World Bank.
  5. 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).
  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. 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.
  8. 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.
  9. 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.
  10. repec:sae:ecolab:v:16:y:2006:i:2:p:1-2 is not listed on IDEAS
  11. 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.
  12. 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.
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