Weather Derivatives Basis Risk Quantifying and Hedging Effect

Abstract

Abstract:

Weather derivatives have achieved remarkable effects in hedging weather risks in foreign countries, but its inner geographical basis risk reduces the degree of market acceptance. We decrease the geographical basis risk of weather derivatives by increasing the space diversity, on the basis of quantifying the geographical basis risk. To minimize the geographical basis risk, we need to know the joint distribution of rainfall in different regions, so we estimate the randomly generated model of rainfall to get the weight of optimal geographic combination. The study shows that, compared with the traditional historical data simulation method and inverse distance weighting method, this new method can be more effective in reducing the geographical basis risk of weather derivatives, and it can copy the revenue of weather-sensitive companies under general weather risks, so it is helpful to improve the enthusiasm enterprises to purchase weather derivatives.

Key words: weather derivatives, weather risk, geographical basis risk, root mean square error

Li Yong, Ma Yu, Cui Xigang. Weather Derivatives Basis Risk Quantifying and Hedging Effect[J]. , 2015, 27(10): 33-43.

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