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Advances in Meteorology
Volume 2013 (2013), Article ID 146036, 8 pages
http://dx.doi.org/10.1155/2013/146036
Research Article

A Methodical Approach to Design and Valuation of Weather Derivatives in Agriculture

Department of Business Economics, University of Economics, Prague, W. Churchill Square 4, 130 67 Prague 3, Czech Republic

Received 5 December 2012; Revised 17 April 2013; Accepted 27 May 2013

Academic Editor: Ismail Gultepe

Copyright © 2013 Jindrich Spicka and Jiri Hnilica. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

The paper deals with weather derivatives as the potentially effective risk management tool for agricultural enterprises seeking to mitigate their income exposure to variations in weather conditions. Design and valuation of the weather derivatives is an interdisciplinary approach covering agrometeorology, statistics, mathematical modeling, and financial and risk management. This paper first offers an overview of data sources and then methods of design and valuation of weather derivatives at the regional level. The accompanied case study focuses on cultivation of cereals (wheat and barley) in the Czech Republic. However, its generalizability is straightforward. The analysis of key growing phases of cereals is based on regression analysis using weather indices as the independent variables and crop yields as dependent variables. With the bootstrap tool, the burn analysis is considered as useful tool for estimating uncertainty about the payoff, option price, and statistics of probability distribution of revenues. The results show that the spatial and production basis risks reduce the efficiency of the weather derivatives. Finally, the potential for expansion of weather derivatives remains in the low income countries of Africa and Asia with systemic weather risk.