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Hedging Crop Yields Against Weather Uncertainties—A Weather Derivative Perspective

1
Institute for Basic Sciences, Technology, and Innovation, Pan African University, Nairobi, Kenya
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School of Mathematics, University of Nairobi, Nairobi, Kenya
3
African Institute for Mathematical Sciences, Cape Town, South Africa
4
Department of Statistics and Probability, College of Natural Science, Michigan State University, 220 Trowbridge Rd, East Lansing, MI 48824, USA
*
Author to whom correspondence should be addressed.
Math. Comput. Appl. 2019, 24(3), 71; https://doi.org/10.3390/mca24030071
Received: 4 May 2019 / Revised: 10 July 2019 / Accepted: 18 July 2019 / Published: 19 July 2019
(This article belongs to the Section Natural Sciences)
The effects of weather on agriculture in recent years have become a major global concern. Hence, an effective weather risk management tool (i.e., weather derivatives) that can hedge crop yields against weather uncertainties is needed. However, most smallholder farmers and agricultural stakeholders are unwilling to pay for the price of weather derivatives (WD) because of the presence of basis risks (product-design and geographical) in the pricing models. To eliminate product-design basis risks, a machine learning ensemble technique was used to determine the relationship between maize yield and weather variables. The results revealed that the most significant weather variable that affected the yield of maize was average temperature. A mean-reverting model with a time-varying speed of mean reversion, seasonal mean, and local volatility that depended on the local average temperature was then proposed. The model was extended to a multi-dimensional model for different but correlated locations. Based on these average temperature models, pricing models for futures, options on futures, and basket futures for cumulative average temperature and growing degree-days are presented. Pricing futures on baskets reduces geographical basis risk, as buyers have the opportunity to select the most appropriate weather stations with their desired weight preference. With these pricing models, farmers and agricultural stakeholders can hedge their crops against the perils of extreme weather. View Full-Text
Keywords: basis risk; agricultural risk management; weather derivatives; cumulative average temperature; growing degree-days basis risk; agricultural risk management; weather derivatives; cumulative average temperature; growing degree-days
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Gyamerah, S.A.; Ngare, P.; Ikpe, D. Hedging Crop Yields Against Weather Uncertainties—A Weather Derivative Perspective. Math. Comput. Appl. 2019, 24, 71.

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