Free Access

Hedging rainfall risk: An illustrative analysis of rainfall index-based futures contracts

N. Dileep

https://orcid.org/0000-0001-5159-3799

PG Department of Commerce, MMK SDM Mahila Mahavidyalaya, Mysuru, Karnataka 570 004, India

E-mail Address: dileepn@commerce.uni-mysore.ac.in

Corresponding author.

Search for more papers by this author

and

G. Kotreshwar

https://orcid.org/0000-0003-3574-8839

Department of Studies in Commerce, University of Mysore, Mysuru, Karnataka 570 006, India

E-mail Address: kotreshwar@commerce.uni-mysore.ac.in

Search for more papers by this author

https://doi.org/10.1142/S2424786323500597Cited by:0 (Source: Crossref)

Abstract

Various studies have attempted to explore rainfall index (RI)-based derivatives as a tool to hedge rainfall risk. But no study delved into the issue to discuss the potential deployment of those tools for hedging rainfall risk on a model based on RI-based futures (RIBFs). An illustrative analysis of RIBFs contracts as hedging instruments has been undertaken in this study. The study is fundamentally based on empirical data. A brief account of the rainfall risk profile is presented to indicate the risk diversification opportunity. Besides, the results of an analysis of the correlation between the RI and the stock market index are projected to establish the RI as a unique asset class. The monsoon rainfall data for 50 years, i.e., from 1971 to 2020 have been considered. The Sensex and Nifty stock market indices data covered a period of 30 years, from 1991 to 2020. The study used correlation, the GARCH (1,1) model, and ratio analysis to test the hypotheses. A hypothetical insurance company representing major stakeholders in need of rainfall risk hedging has been taken as an example for evaluating the utility of RIBFs contracts as hedging tools. The results reveal that the party buying RIBFs contracts can significantly reduce the loss of revenue due to adverse monsoon outcomes.

Keywords:

JEL: G10, G13, G15, G23, G52

References

Andrea, S and H Ulrich [2003] Design and use of weather derivatives in agricultural policies: The case of rainfall index insurance in Morocco, International Conference, Capri, Italy, pp. 1–17. https://doi.org/10.1.1.631.7422&rep=rep1&type=pdf Google Scholar
Bharath, V and G Kotreshwar [2022] Modelling and designing of rainfall derivative contract in India, KIIT Journal of Management, 18(1), 11–27. https://doi.org/10.23862/kiit-parikalpana/2022/v18/i1/212343 Google Scholar
Bharath, V, N Dileep and G Kotreshwar [2022] Evaluating the monsoon (rainfall) risk profile for feasibility of rainfall derivatives instruments in India, Mudra: Journal of Finance and Accounting, 9(1), 56–74. Crossref, Google Scholar
Chengyi, P, C Yueyun (Bill) and P Xiaojun [2018] Weather indexes, index insurance and weather index futures, Insurance Markets and Companies, 9(1), 33–40. https://doi.org/10.21511/ins.09(1).2018.04 Google Scholar
Chinnadurai, K, S Murugesan, S Marxia Oil and K Indulekha [2019] A empirical note on Delhi weather effects in the Indian Stock Market, International Journal of Recent Technology and Engineering, 8(4), 1203–1208. https://doi.org/10.35940.C4727.118419 Google Scholar
Dileep, N, V Bharath, VS Jyothi and G Kotreshwar [2021] Rainfall index based futures: A tool for absorbing systemic monsoon risk, Mukt Shabd Journal, X(VI), 232–240. Google Scholar
Dileep, N and G Kotreshwar [2022] Interrelationship between the rainfall index and NSE Nifty Index: An empirical study, South India Journal of Social Sciences, XX(2), 83–94. Google Scholar
Dileep, N and G Kotreshwar [2023] Theoretical framework to introduce rainfall index-based futures contracts in India, Theoretical and Applied Economics, 2(635), 183–198. Google Scholar
Farrukh, S [2019] Does weather influence investor behaviour, stock returns, and volatility? Evidence from the greater China region, Elsevier Physica A, 526, 525–543. https://doi.org/10.1016/j.physa.2019.02.015 Google Scholar
Japleen, KN, G Dhanuka, TN Devyansh and A Deeksha [2021] The impact of precipitation on stock market returns in India, International Journal of Research in Engineering, Science and Management, 4(1), 96–102. Google Scholar
Jindrich, S and H Jiri [2013] A methodical approach to design and valuation of weather derivatives in agriculture, Advances in Meteorology, 2013, 1–8. https://doi.org/ 10.1155/2013/146036 Google Scholar
Joshua, DW and G Philip [2016] Basis risk and weather hedging effectiveness, Agricultural Finance Review, 68(1), 99–117. https://doi.org/10.1108/00214660880001221 Google Scholar
Kotreshwar, G and M Kanakasabai [2006] Design and pricing of monsoon derivatives: A conceptual framework, International Conference Organised by Asia Pacific Risk And Insurance (Apria), Tokyo, Japan. Google Scholar
Kotreshwar, G [2015] Securitisation of rainfall risk in india: designing rainfall derivative contracts based on standard metrics, International Conference on Emerging Trends in Finance Accounting, SDM-IMD, Mysuru, India. Google Scholar
Manfredo, MR and TJ Richards [2014] Hedging with weather derivatives: A role for option in reducing basis risk, Applied Financial Economics, 19, 87–97. https://doi.org/10.1080 09603100701765166 Crossref, Google Scholar
Melanie Cao, A and W Jason [2004] Precipitation modelling and contract valuation: A frontier in weather derivatives, The Journal of Alternative Investments, 7(2), 93–99. https://doi.org/10.3905/jai.2004.439656 Crossref, Google Scholar
Miriam, E [2005] Issues of geographical basis risk in weather derivatives for Australian wheat farmers, Annual Conference of the Australian Agricultural and Resource Economics Society, Coffs Harbour, Australia. Google Scholar
Rajiv, S, VA Ansari and M Datta [2009] Design and use of weather derivatives for farmers: The case of hedging rain risk by soyabean growers in Jhalawar district in India, International Journal of Financial Markets and Derivatives, 1(1), 49–63. Crossref, Google Scholar
Raju, KV, G Naik, R Ramseshan, T Pandey, P Joshi, KH Anantha, AVR Kesava Rao, D Moses Shyam and D Kumara Charyulu (2016). Transforming weather index-based crop insurance in India: Protecting small farmers from distress. Status and a way forward. Research Report IDC-8. Patancheru 502 324. Telangana, International Crops Research Institute for the Semi-Arid Tropics, India, 36 pp. Google Scholar
Ritter, M, O Mubhof and M Odenning (2012). Minimizing geographical basis risk of weather derivatives using a multi-site rainfall model, 123rd Seminar, February 23-24, 2012, Dublin, Ireland 122527, European Association of Agricultural Economists. DOI: 10.22004/ag.econ.122527. Google Scholar
Vedenov, DV and BJ Barnett [2004] Efficiency of weather derivatives as primary crop insurance instruments, Journal of Agricultural and Resource Economics, 29(3), 1–17. https://doi.org/10.22004/ag.econ.30916 Google Scholar
Veeramini, VN, LJ Maynard and Skees [2003] Assessment of the risk management potential of a rainfall based insurance index and rainfall options in Andra Pradesh, India, Indian Journal of Economics and Business, 1, 195–208, http://dx.doi.org/10.22004/ag.econ.22183. Google Scholar