Calum G. Turvey

Weather Derivatives for Specific Event Risks in Agriculture

This paper examines the economics and pricing of weather derivatives in Ontario and argues that weather derivatives and weather insurance can be used as a form of agricultural insurance. Using historical data, the relationship between crop productivity and weather is examined. Then a variety of put and call options for rain- and heat-based weather risk are discussed and numerically evaluated. The evaluation examines in detail the pricing of insurance contracts at a given location and across space.

Poverty Traps and Climate Risk: Limitations and Opportunities of Index-Based Risk Financing

The objective of this paper is to frame the key issues and summarize the current state of knowledge about and innovations in index-based risk transfer products (IBRTPs) as they relate to the management of climate risk for poverty reduction, especially of chronic or persistent poverty. In the past several years, interest in and experimentation with weather index insurance and other IBRTPs has grown rapidly. Though no one should expect that these innovations alone can solve the problem of chronic poverty, index-based financing opens up a range of intriguing possibilities. The remainder of this paper is comprised of five major sections that discuss: 1) how weather risks and climate shocks impact the poor in developing countries; 2) the concept of poverty traps, highlighting how conventional risk management strategies typically do not work well for managing covariate weather risk; 3) the limitations and opportunities of financial innovations using index-based risk transfer products (IBRTPs) for reducing or transferring weather risks and climate shocks; 4) a poverty traps-based typology of IBRTPs; 5) key remaining challenges in developing and implementing index-based risk financing for use in the global struggle to end chronic poverty.

THE PRICING OF DEGREE-DAY WEATHER OPTIONS

This paper presents a model and framework for pricing degree‐day weather derivatives when the weather variable is a non‐traded asset. Using daily weather data from 1840S1996, it is shown that a degree‐day weather index exhibits stable volatility and satisfies the random walk hypothesis. The options prices from the recommended model are compared to a typical insurance‐type model. The results show that the insurance model overprices the option value at‐the‐money, and this may explain why the bid‐ask spread in the weather derivatives market is sometimes very large.

The relationship between economic value added and the stock market performance of agribusiness firms

This article examines the relationship between economic value added (EVA) and the stock market performance of 17 publicly traded companies in the Canadian food processing sector. The research is motivated by the increased popularity of EVA in corporate finance and by the claims that high EVA causes incremental gains in share price values. Using1996 annual reports to compute EVA, and daily stock prices for 1994 through 1998, we attempt to correlate EVA with a variety of measures including accounting return on assets (ROA), return on equity (ROE), share price, the Capital Asset Pricing Model (CAPM) returns and risk, and others. Results find little support for the conjecture that high-EVA firms lead to higher shareholder value, however, because the management logic that has popularized EVA is so logical and fundamental to common practices in corporate finance that we resist dismissing EVA as a valued paradigm. Rather, we suggest that market volatility and other factors mask the short-run increments to shareholder wealth from EVA-implemented strategies. lEconLit citations: G30, Q13.r

Weather risk and the viability of weather insurance in China's Gansu, Shaanxi, and Henan provinces

Purpose - The purpose of this paper is to investigate weather risks facing Chinese farmers, and to determine whether farmers would have a preference for weather insurance over other types of agricultural insurance. Design/methodology/approach - The data are based on 1,564 farm households surveyed in Shaanxi, Henan, and Gansu provinces in Central China between October 2007 and 2008. Findings - Results suggest that the greater risk for farmers is drought followed by excessive rain. Heat is less critical as a risk but more significant than cool weather. Results suggest a strong interest in precipitation insurance with 50 and 44 percent of respondents indicating strong interest in the product. Supplementary results indicate that interest is equal between planting, cultivating, and harvesting. Furthermore, results suggest that farmers are willing to adopt new ideas, and where possible action has already been taken to self-insure through diversification and other means. Research limitations/implications - This research is based on primary data gathered in China. However, the authors are limited in the access to Chinese weather station data to illustrate how weather insurance operates. Instead, the authors use weather data from the weather station in Ashland, Kansas which has similarities to the wheat growing regions of China. While the example is for illustrative purposes only, the authors cannot claim that it actually represents premiums that might actually be found in China. Practical implications - The Chinese Government has within the past year authorized an investigation into agricultural insurance. The burst of research and applications of weather insurance in both developed and developing countries suggest that a wide array of applications could be feasible in China. The results are encouraging because they suggest that farmers in China would have an interest in purchasing weather insurance. Originality/value - The authors believe that this is the first study conducted on weather insurance in China. The survey instrument is designed to specifically determine what weather risks are important to Chinese farmers and the interest that farmers would have in using such a product.

Identifying Management Profiles of Ontario Swine Producers through Cluster Analysis

This paper develops managerial profiles of Ontario Swine Producers for extension use, using mail survey data and cluster analysis. Results indicate that there are four major discriminant variables that can be used to identify different classes of farmers. These management profiles can be used for targeted extension efforts.

Quantifying spatial basis risk for weather index insurance

Purpose - The purpose of this paper to develop an empirical methodology for managing spatial basis risk in weather index insurance by studying the fundamental causes for differences in weather risk between distributed locations. Design/methodology/approach - The paper systematically compares insurance payouts at nearby locations based on differences in geographical characteristics. The geographic characteristics include distance between stations and differences in altitude, latitude, and longitude. Findings - Geographic differences are poor predictors of payouts. The strongest predictor of payout at a given location is payout at nearby location. However, altitude has a persistent effect on heat risk and distance between stations increases payout discrepancies for precipitation risk. Practical implications - Given that payouts in a given area are highly correlated, it may be possible to insure multiple weather stations in a single contract as a “risk portfolio” for any one location. Originality/value - Spatial basis risk is a fundamental problem of index insurance and yet is still largely unexplored in the literature.

Whole Farm Income Insurance

This article employs a mathematical programming model to investigate farmers’ optimal crop choices under gross revenue insurance, whole farm income insurance (WFI), the Canadian Agricultural Income Stabilization (CAIS) program, and its modified 2008 program AgrInvest. WFI poses a particularly interesting problem since the indemnity/premium structure is dependent upon the choice of crops, whereas the choice of crops is simultaneously influenced by the presence of the whole farm insurance program. Results indicate that farmers will alter farm plans significantly in response to the type of insurance offered and the level of subsidy.

Improving Humanitarian Response to Slow-Onset Disasters Using Famine Indexed Weather Derivatives

This paper illustrates how weather derivatives indexed to forecasts of famine can be designed and used by operational agencies and donors to facilitate timely and reliable financing, for effective emergency response to climate‐based, slow‐onset disasters such as drought. We provide a general framework for derivative contracts, especially in the context of index insurance and famine catastrophe bond, and show how they can be used to complement existing tools and facilities in drought risk financing through a risk‐layering strategy. We use the case of arid lands of northern Kenya, where rainfall proves a strong predictor of widespread and severe child wasting, to provide a simple empirical illustration of the potential contract designs.

Systematic and Nonsystematic Risk in Farm Portfolio Selection

The concepts of systematic and nonsystematic risk are evaluated as risk measures in farm planning models. A diagonal quadratic programming model based upon a single-index model yields farm plans similar to the full variance-covariance quadratic program with four of thirteen farm plans being identical. Surprisingly, a linear programming model using only systematic risk produces farm plans that are identical to the full variance-covariance quadratic program for eleven of thirteen income levels. Accordingly, it is suggested that single-index-based programming models may prove to be practical alternatives for deriving mean-variance-efficient farm plans.