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Basis Risk and Weather Hedging Effectiveness

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  • Woodard, Joshua D.
  • Garcia, Philip

Abstract

Basis risk has been cited as a primary concern for implementing weather hedges. This study investigates several dimensions of weather basis risk for the U.S. corn market at various levels of aggregation. The results suggest that while the degree of geographic basis risk may be significant in some instances, it should not preclude the use of geographic cross-hedging. In addition, the degree to which geographic basis risk impedes effective hedging diminishes as the level of spatial aggregation increases. In fact, geographic basis risk is actually negative in the case most representative of a reinsurance hedge, and the reduction in risk from employing straightforward temperature derivatives is significant. Finally, precipitation hedges are found to introduce additional product basis risk. The findings may be of interest to decision makers considering using exchange traded weather derivatives to hedge agricultural production and insurance risk.

Suggested Citation

  • Woodard, Joshua D. & Garcia, Philip, 2007. "Basis Risk and Weather Hedging Effectiveness," 101st Seminar, July 5-6, 2007, Berlin Germany 9254, European Association of Agricultural Economists.
  • Handle: RePEc:ags:eaa101:9254
    DOI: 10.22004/ag.econ.9254
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    References listed on IDEAS

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    1. 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(1), pages 1-14, July.
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    4. Mason, Chuck & Hayes, Dermot J. & Lence, Sergio H, 2003. "Systemic risk in U.S. crop reinsurance programs," ISU General Staff Papers 200304010800001293, Iowa State University, Department of Economics.
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    7. Patrick L. Brockett & Mulong Wang & Chuanhou Yang, 2005. "Weather Derivatives and Weather Risk Management," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 8(1), pages 127-140, March.
    Full references (including those not matched with items on IDEAS)

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