Weather derivative design in agriculture – a case study of barley in the Southern Moravia Region

Abstract

The aim of this paper is to point out some problems of index estimation for the purposes of weather derivative valuation considering the particularities of agriculture. The assessment of the sensitivity of barley to weather over 40 years has been the basis for the design and valuation of weather derivative in the Czech Republic (The Southern Moravia Region). The analysis is based on regression modeling using temperature index and barley yield. The burn analysis based on parametric bootstrap is used as the method for the valuation of weather derivative contract. With the effective bootstrap tool, the burn analysis may easily be processed and the uncertainty about the pay-off, option price and statistics of probability distribution of revenues can be effectively determined. Nevertheless, the results of the analysis reveal a significant adverse impact of basis risk on the quality of agricultural weather derivative in the Czech growing conditions. The article outlines the scope for use of weather derivative as the reinsurance tool in regions with frequent occurrence of systematic weather risk.