Academic journal article Agricultural and Resource Economics Review

An Internet-Based Tool for Weather Risk Management

Academic journal article Agricultural and Resource Economics Review

An Internet-Based Tool for Weather Risk Management

Article excerpt

This paper introduces a web-based computer program designed to evaluate weather risk management and weather insurance in the United States. The paper outlines the economics of weather risk in terms of agricultural production and household well-being; defines weather risk in terms of intensity, duration, and frequency; and illustrates the computer program use by comparing heat and precipitation risks at Ardmore, Oklahoma, and Ithaca, New York.

Key Words: weather insurance, heat insurance, precipitation insurance, crop insurance, weather derivatives

(ProQuest: ... denotes formulae omitted.)

The pricing of weather insurance, and more generally the enumeration of weather risk, is not an easy task. Data are not so easily accessible, and assessing the data in terms of all of the possibilities of risk is burdensome (Campbell and Diebold 2003, Changnon and Changnon 1990). Furthermore the numbers of possibilities are virtually endless, and what might be an insurable weather risk at one location may not be insurable at another. It is for this reason that academic research has focused so heavily on the general rules of probability that govern loss and weather insurance/derivative premiums rather than on making broad generalized statements about application (Turvey 2005).

There are two gaps in the literature. The first is rudimentary. The literature on weather risk management as cited above focuses more on insurability than on how weather interacts with agricultural production and farm households as a source of risk. The idea that weather and crop yields represent covariate risks is taken as given and the effects of climate and weather variance on crop production has long been understood (Bardsley, Abey, and Davenport 1984, Changnon 2003, Huff and Neill 1982, Runge 1968). A more complete understanding of how covariate risks evolve in a production system, even at the conceptual level, can provide invaluable insights to the practitioner and theorist. In this paper we present such a model. It is not a precise model, nor are we in a position to empirically validate the model, but it does provide the requisite insight to understanding covariate risk and how covariate risks interact with farm livelihoods to create an insurable condition.

The second gap, and the focal point of this paper, is the measurement of weather risk and the insurability of weather risk. Despite recent interest in weather insurance, the idea of insuring weather risk as an alternative to crop insurance is not new (several articles predating 2000 that made such propositions include Changnon and Changnon 1990, Gautman, Hazell, and Alderman 1994, Quiggen 1986, Patrick 1998, Sakurai and Reardon 1997). Since 2000, a variety of weather insurance models, propositions, theorems, and structures have been proposed, but there is little agreement on how weather risk should be defined or how weather insurance should be priced [Alaton, Djehiche, and Stillberger 2002, Alderman and Haque 2006, Cao and Wei 2004, Considine (undated), Davis 2001, Dischel 2002, Geman 1999, Jewson and Brix 2005, Leggio and Lien 2002, Muller and Grandi 2000, Nelken 1999, Richards, Manfredo, and Sanders 2004, Turvey 2001, Turvey 2005, Zeng 2000]. Applications of weather insurance in North America, Europe, and developing economies are varied and include numerous important contributions to a range of issues including agricultural production risk, food security, poverty alleviation, irrigation insurance, intertemporal risks, and so on (Alderman and Haque 2006, Hao and Skees 2003, Hazell, Oram, and Chaherli 2001, Hazell and Skees 2006, Hess, Richter, and Stoppa 2002, Lacoursiere 2002, Leiva and Skees 2005, Mafoua and Turvey 2003, Martin, Barnett, and Coble 2001, Muller and Grandi 2000, Skees, Hartell, and Hao 2006, Skees et al. 2001, Stoppa and Hess 2003, Turvey, Weersink, and Chiang 2006, Vedenov and Barnett 2004, Veeramani, Maynard, and Skees 2003).

Part of the problem is that use of the term "weather risk" is far too ubiquitous, and agricultural economists seeking agreement on a definition of weather risk will ultimately be disappointed. …

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