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Designing rainfall index based futures contracts: analysis of basis risk

Author

Listed:
  • N. Dileep
  • G. Kotreshwar

Abstract

The basis risk is the difference between rainfall recorded in meteorological subdivisions (MSD) and rainfall recorded in rain gauge stations. Basis risk is an inherent problem in rainfall index-based derivatives contracts, because the payout in rainfall index-based derivatives depends on the strike and actual rainfall recorded at the locations where parties entered into the contract. As a result, the proposed study seeks to ascertain whether a basis risk exists in the South Interior Karnataka Meteorological Subdivision (SIK MSD). The study used monthly monsoon rainfall data for the years 2013-2020. The statistical tools like mean, standard deviation, coefficient of variation, and correlation analysis show that there is a basis risk in SIK MSD. The result of the hypothesis testing with the t test proved that there is a basis risk in SIK MSD for the study period. Therefore, the study designed city-based rainfall index-based futures (RIBF) contracts for the farming community and MSD-based RIBF contracts for those who are willing to take the contracts on a pan-India basis.

Suggested Citation

  • N. Dileep & G. Kotreshwar, 2023. "Designing rainfall index based futures contracts: analysis of basis risk," International Journal of Financial Markets and Derivatives, Inderscience Enterprises Ltd, vol. 9(3), pages 170-187.
    • Handle: RePEc:ids:ijfmkd:v:9:y:2023:i:3:p:170-187
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