The author through thispaper, brings out the importance of weather derivative to mitigate theagriculture risk factors and also in terms of cost saving and markettransparency. A financial weather contract is an instrument used by anindividual or a company to insure against the risk of unforeseen weathercondition. It is of two type; Weather Derivative (WD) and Weather Insurance(WI).
If a company’s revenue isaffected by the temperature, sunshine or snowfall, it can reduce the loss withthe help of weather derivatives. The author explains this with a help of anexample; a golf course owner might want to reduce the risk of revenue lossduring the rainy days. The first weather derivative index was Heating DegreeDay (HDD) index in relation to winter temperature risk and Cooling Degree Day (CDD)in relation to summer temperature risk.
It was introduced to correlate temperatureand revenue fluctuations. The scope of weatherderivate is expanding with the availability of adequate weather reports and statisticsas many developed and developing countries have extensive and reliable data onweather. The pricing of WDs is very differentfrom that of the ordinary commodity or financial derivative.
As in case of WDsthere are no underlying traded assets. In the absence of tradable asset there areabsolutely no possible chances of developing weather futures contract. The pricing model for these is based on actuarialcalculations.
There is a lack of markettransparency and increased cost of transaction in the absence of universalpricing mechanism.Technology plays animportant role in transmitting the information globally. Many agriculture deals already use the vegetativeindex to as insurance triggers. Soil humidity measure, which is vital for plantgrowth is now shown directly on the traders screen. These hi-tech equipmentsnot only help farmers in greater production but also help the investors in makinganalyzed investments.
The author further gives an elaborate example ofRainfall Index Derivatives used in Morocco. He draws a relation between weatherfactor and specific factor. Through this he tries to lay emphasis as howdifferent crops require different amount of rainfall.
He also analysis theperformance of weighted rainfall index.