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Optimal Design of Weather Bonds

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  • Xu, Wei
  • Odening, Martin
  • Musshoff, Oliver

Abstract

This paper investigates the optimal design of weather bonds for reinsurance purposes. The motivation for this task comes from an empirical study showing that German farmers are not willing to pay the premiums for weather insurance that insurers ask for. Since reinsurance costs constitute a major cost component of insurance premiums, minimizing these costs could decrease the observed gap between the willingness to pay and the willingness to accept the cost of the insurance. Against this background, we put forth the proposal to transfer weather risk directly to the capital market by issuing weather bonds. The structure of the weather bond is optimally designed in a utility maximizing framework that involves farmers, insurers, and capital market investors. The approach is illustrated by an example of securitizing draught risk in crop production in Germany.

Suggested Citation

  • 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).
  • Handle: RePEc:ags:aaea08:6781
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    File URL: http://ageconsearch.umn.edu/record/6781/files/459328a.pdf
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    References listed on IDEAS

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    1. Froot, Kenneth A. & O'Connell, Paul G.J., 2008. "On the pricing of intermediated risks: Theory and application to catastrophe reinsurance," Journal of Banking & Finance, Elsevier, vol. 32(1), pages 69-85, January.
    2. 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.
    3. Jerry R. Skees & Barry J. Barnett & Anne G. Murphy, 2008. "Creating insurance markets for natural disaster risk in lower income countries: the potential role for securitization," Agricultural Finance Review, Emerald Group Publishing, vol. 68(1), pages 151-167, May.
    4. 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.
    5. Raviv, Artur, 1979. "The Design of an Optimal Insurance Policy," American Economic Review, American Economic Association, vol. 69(1), pages 84-96, March.
    6. Olivier Mahul, 2001. "Managing Catastrophic Risk Through Insurance and Securitization," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(3), pages 656-661.
    7. Pauline Barrieu & Nicole El Karoui, 2002. "Reinsuring Climatic Risk Using Optimally Designed Weather Bonds," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 27(2), pages 87-113, December.
    8. 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.
    9. 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.
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    Cited by:

    1. Wei Xu & Guenther Filler & Martin Odening & Ostap Okhrin, 2010. "On the systemic nature of weather risk," Agricultural Finance Review, Emerald Group Publishing, vol. 70(2), pages 267-284, August.

    More about this item

    Keywords

    Agricultural Finance; Risk and Uncertainty;

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