Weather insurance design with optimal hedging effectiveness
I construct index-based weather insurance contracts with optimal hedging effectiveness for the insured or maximal profits for the insurer. In contrast to earlier work, I refrain from imposing functional form assumptions on the stochastic relationship between weather and yield and from restricting attention to (piecewise) linear contracts. Instead, I derive the shape of the optimal weather insurance contracts empirically by non-parametrically estimating yield distributions conditional on weather. I find that the optimal pay-off structure is non-linear for the entire range of weather realizations. I measure risk reduction of optimal weather insurance contracts for different weather indices and levels of risk aversion. Considering profit-maximizing contracts, I find that at modest levels of risk aversion (coefficient of relative risk aversion around 2), a loading factor of 10% of the fair premium is possible such that the insurance contract remains attractive for the insured. With higher levels of risk aversion, loading of more than 50% becomes possible.
|Date of creation:||01 Jun 2011|
|Contact details of provider:|| Postal: Ludwigstraße 33, D-80539 Munich, Germany|
Web page: https://mpra.ub.uni-muenchen.de
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- Oliver Musshoff & Martin Odening & Wei Xu, 2009. "Management of climate risks in agriculture-will weather derivatives permeate?," Applied Economics, Taylor & Francis Journals, vol. 43(9), pages 1067-1077.
- 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.
- 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.
- Olivier Mahul, 2001. "Optimal Insurance Against Climatic Experience," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(3), pages 593-604.
- Olivier Mahul & Brian D. Wright, 2003.
"Designing Optimal Crop Revenue Insurance,"
American Journal of Agricultural Economics,
Agricultural and Applied Economics Association, vol. 85(3), pages 580-589.
- Mahul, Olivier & Wright, Brian D., 2000. "Designing Optimal Crop Revenue Insurance," 2000 Annual meeting, July 30-August 2, Tampa, FL 21729, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
- 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.
- 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.
- Olivier Mahul, 1999. "Optimum Area Yield Crop Insurance," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(1), pages 75-82. Full references (including those not matched with items on IDEAS)
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